Tag Archive for: pensions

California Supreme Court Finally Rules on Case Affecting Pensions

On Thursday the California Supreme Court issued its ruling in the case Alameda County Deputy Sheriff’s Association vs Alameda County Employees’ Retirement Association. In plain English, this was a case where attorneys representing government unions were challenging pension reforms enacted by California’s state legislature in 2013. The ruling, which had the potential to empower dramatic changes to pension benefit formulas, was measured. But it is generally considered a victory for the plaintiffs.

Pete Constant, CEO of the Retirement Security Initiative, which advocates “fair and sustainable public sector retirement plans,” found the ruling encouraging, stating “the court has confirmed that the public interest is of utmost concern when determining whether public pensions need reform.”

What advocates for financially sustainable pensions are up against is the so-called “California Rule,” an interpretation of California contract law that dramatically limits the ways in which elected officials, or voters in a ballot measure, can modify pension benefits for public employees. The prevailing interpretation of the California Rule is that it prohibits changes to pension benefit formulas for active public employees, even for work they have not yet been performed.

In practical terms, obeying the California Rule means that whatever pension benefit package was in place on the date a public employee was hired must be maintained throughout their career. If it is changed, the employee must be given a compensatory new benefit of equal value.

Pension benefit formulas for California’s state and local public employees are typically calculated based on three variables – how many years the employee worked, how much the public employee earned in their final year of employment, and a “multiplier” that is applied to the product of these two values. For example, a public employee who has worked for 30 years, making $100,000 in their final year of work, whose pension “multiplier” was 3 percent, would get a pension equal to 30 x $100K x 3%, or $90,000.

During Jerry Brown’s second eight year stint as Governor of California, he consistently advocated for pension reform, claiming the unforeseen and escalating costs to fund public employee pensions were putting an unsustainable burden on civic budgets and taxpayers. The reform he pushed through the California State Legislature, the Public Employee Pension Reform Act of 2013 (PEPRA), was an attempt to curb what were seen as abuses in public pension systems. Passage of PEPRA immediately generated litigation by attorneys representing public sector unions.

In an earlier case decided in 2019, Cal Fire Local 2881 v. California Public Employees’ Retirement System, the court upheld PEPRA’s prohibition of the purchase of so-called “airtime,” which manipulated a pension calculation variable by increasing the number of years an employee worked.

In this case, the court upheld PEPRA’s amended definition of another pension calculation variable, how much they earned in their final year of employment. This PEPRA provision was designed to “exclude or limit the inclusion of additional types of compensation in an effort to prevent perceived abuses of the pension system.”

The various ways in which PEPRA attempted to end these practices that critics refer to as “pension spiking” have been repeatedly challenged by public employee unions in court. Relying on the California Rule, the union argument might reduce to this: “if pension spiking was a common and accepted practice at the time we were hired, then we relied on the ability to eventually spike our pensions back when we made the decision to enter public service. It is a vested right which cannot be taken away.”

The court did not agree. Buried in its nearly 100 page opinion was the following: “They [the provisions of PEPRA] were enacted for the constitutionally permissible purpose of closing loopholes and preventing abuse of the pension system… Further, it would defeat this proper objective to interpret the California Rule to require county pension plans either to maintain these loopholes for existing employees or to provide comparable new pension benefits that would perpetuate the unwarranted advantages provided by these loopholes.”

The implications for future reform are mixed. Jon Holtzman, a partner with the Renne Public Law Group and an expert on the laws governing public sector pensions, was encouraged, saying, “This is a very positive ruling. The court concluded there was not a contractual right to spiking. A more notable aspect of the decision is they once and for all dispelled the notion that if you take away a benefit that you must give a comparable benefit.”

There are two ways this ruling chips away at this core element of the California Rule. First, as noted, the court does not recognize the obligation to “perpetuate the unwarranted advantages provided by these loopholes” by providing a comparable benefit when the loophole is closed. The second way this ruling undermines the California Rule is more ambiguous.

The concurring opinion summarizes this ambiguity. Justice J. Cuellar writes “The test the court applies here is merely a specific application, fit for this situation, of a more general inquiry: whether a reduction in pension rights without any comparable new advantages is ‘reasonable’ and ‘necessary’ to further ‘an important state interest…'”

There’s a lot to unpack here. First, the ruling does not invalidate the prevailing interpretation of the California Rule, it makes clear the court is looking at a specific application – namely, what constitutes pension eligible pay when calculating a retirement pension. Secondly, it is implying that if the plaintiff can demonstrate that a provision of PEPRA, or any other pension reform that might come along, requires unnecessary or unreasonable reductions to pension benefits in pursuit of “an important state interest,” then the California Rule may still be applicable, preventing those reforms. Finally, though, what constitutes an “important state interest?”

This question awaits another court case for further clarification, and it could be the answers continue to arrive only in the context of specific applications of the question. Yet on this question hinges the ability of pension reformers to enact more meaningful modifications to public sector pension formulas. At what point does modifying public sector pensions become an “important state interest?” When they’ve become too expensive? They’re already too expensive. Or when the burden of paying them propels an agency into bankruptcy? And what if instead of bankruptcy, agencies – cities and counties and special districts – simply cut services and staff in order to cover operating deficits, and leave the pensions intact?

Pete Constant, commenting on the limited scope of today’s ruling, said “with the uncertainty we’re seeing today, this would have been a good time for the California Supreme Court to issue a broad decision.”

Carl DeMaio, the former San Diego City Councilman who has spent decades pushing for pension reform, was less subtle. In a blistering press release, he said “By crafting a narrow ruling that sidesteps the fundamental flaws with the notorious California Rule, the California Supreme Court seems hell bent on forcing California taxpayers to bear the excessive costs of unsustainable pension payouts for state and local government employees.”

They’re both right. The economic uncertainty ahead for California’s public agencies, as Constant warns, will demand further action to reduce pensions. Pension payouts, as DeMaio says, are excessive and unsustainable.

Future reforms, either initiated by the legislature, citizen initiatives, or bankruptcy courts, may have to take aim at more substantial elements of pension benefit formulas. To list just a few: reducing the multiplier for future work, reducing the cost-of-living adjustment for retirees, requiring active public employees to personally contribute more to the pension system via payroll withholding.

The ruling this week did not go far enough. But it reinforced earlier precedents that make clear the California Rule will not apply in all cases, and it left open the door to define an “important state interest” in a manner that is broad enough to empower more substantial reforms in the future.

This article originally appeared on the website California Globe.

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Post-Coronapocalypse Pension Reform Checklist for California

In a perfect world, California’s state and local public employees would receive exactly the same retirement benefits as federal employees. They would receive a modest defined benefit, a contributory 401K, and they would participate in Social Security.

Unfortunately, in California, while some state and local public employees are offered 401Ks, and many participate in Social Security, all of them rely inordinately on a defined benefit pension. Far from being modest, even the most minimal examples of defined benefit plans for California’s state and local government workers provide roughly twice the value of the typical defined benefit offered federal workers. And where there’s twice the value, there’s twice the cost.

In reality, however, twice the cost would be a bargain. It’s much worse than that, and very little has been done. In 2013, the PEPRA (Public Employee Pension Reform Act) legislation lowered pension benefit formulas in an attempt to restore financial sustainability to California’s public employee pensions. But these revisions, which resulted in defined benefit formulas only about twice as generous as the federal formulas, only applied to new employees.

California’s Pension Systems Were Crashing Before the Coronapocalypse

Two years ago, and after more than eight years of a bull market in the stock market indexes, CalPERS, which is by far the largest pension system in California, had already announced that contributions from participating agencies were going to roughly double. They posted “Public Agency Actuarial Valuation Reports” that disclosed the details per agency.

At the time, in partnership with researchers at the Reason Foundation, the California Policy Center used these reports from CalPERS to summarize the impact on 427 cities and 36 counties (download full spreadsheet). As shown on the table below, two sets of numbers are presented – payments to CalPERS for the 2017-2018 fiscal year, and officially estimated payments to CalPERS in the 2024-25 fiscal year.

The most important distinction one should make when reviewing the above data is the difference between the “normal” and the “catch-up” payments. The so-called “normal contribution” is the amount the employer has to contribute each year to maintain an already fully funded pension system. The “catch-up” or “unfunded contribution” is the additional amount necessary to pay down the unfunded liability of an underfunded pension system.

As can be seen in the example of Millbrae (top row, right), by 2024, the “catch-up” contribution will be nearly six times the amount of the normal contribution. But in the PEPRA reforms, new employees are only required to contribute via payroll withholding to 50 percent of the “normal” contribution.

A separate California Policy Center analysis, also published two years ago, attempted to estimate how much total payments statewide would increase if all of the major pension systems serving California’s state and local public employees were to require similar levels of payment increases. The analysis extrapolated from the consolidated CalPERS projections for their participating cities and counties and estimated that in sum, California’s state and local government employers would have paid $31 billion into the 87 various pension systems in 2018, and by 2024 this payment would rise to $59.1 billion.

As noted at the time, and now more than ever, this was a best case scenario.

A Financial Snapshot of CalPERS Today

The next chart, below, depicts financial highlights for CalPERS – either officially reported or projected – in a format which ought to be publicly disclosed, every quarter, in this format, from every state and local public pension system in California. The first two columns depict data as reported by CalPERS for their most recent two fiscal years, ended 6/30/2018 and 6/30/2019. The final column, which consists of CPC estimates (not provided by CalPERS), shows how their financial condition could appear three months from now.The first thing to note from the above chart is the fact that CalPERS was only 70 percent funded (“funded ratio,” bottom line) in June of 2019. The next thing to note, and this is crucial, is that the actuarial estimates of the total pension liability lags behind one year. That is, the $504.9 billion reported “actuarial accrued liability” is reported as of 6/30/2018, even though that figure is used to report the funded ratio as of 6/30/2019.

Take a deep breath, because the significance of this delay requires further discussion. From page 122 of CalPERS most recent CAFR, here are the trends for the actuarial accrued liability: 6/30/2009 = $294B, 2010 = $308B, 2011 = $328B, 2012 = $340B, 2013 = $375B, 2014 = $394B, 2015 = 413B, 2016 = 436B, 2017 = $465B, and 6/30/2018 = $504B. Based purely on the trend, is there any reason to believe this liability will not exceed $550 billion by June 30, 2020, two years later? Why isn’t that estimate being made?

There’s more. Why are actuaries permitted to have an entire extra year to complete their estimate of the total pension system liability, when changing single variables will cause the estimate to massively fluctuate? Sure, it is a complex exercise, and at some point an official calculation, based on all known data, should be reported that amends a preliminary estimate. But if, for example, you vary the earnings projection downwards from 7.0 percent to 6.0 percent – which needs to be done sooner not later – using calculations provided by Moody’s Investor Services, the amount of the CalPERS liability soars from $550 billion to $621 billion. You don’t split hairs when you’re being scalped.

And what about the employer contribution (second row of data)? Why did it go down from $20 billion in 2018 to $15 billion in 2019? From the “Basic Financial Statements” in the CalPERS CAFRs for the last few years, here are the totals for payments by employers: 2015 = $10.2B, 2016 (page 38-39) = $11.0B, 2017 = $12.4B, 2018 (page 40-41) = $20.0B. With the payment for FYE 6/30/2019 back down to $15.7B, the trends suggest that the large payment of $20.0 billion in 2018 was an anomaly. But assume that much money will come again from employers in 2020. But based on historical trends, probably not more than that. Yet.

Where does this put CalPERS?

All of this discussion is to explain the reasoning behind the figures in column three on the above chart. What might be materially different? What estimate isn’t best case? Does anyone believe CalPERS will actually break even in the return on their invested assets between 6/30/2019 and 6/30/2020? Does anyone believe the most accurate estimate of the total liability belongs anywhere south of $550 billion, particularly when they’re still using a discount rate that’s too high? And yet this puts CalPERS in what is arguably the worst shape it’s ever been, at 64 percent funded as of this June.

This paints a very grim big picture. CalPERS is on track to collect over $20 billion from taxpayers in the current fiscal year, and CalPERS, while the biggest pension system, only manages just over 40 percent of the state and local government pension assets in California. This suggests that the total taxpayer contribution to California’s state and local government pension systems in 2020 is already up to around $50 billion. And it isn’t nearly enough.

Steps to Reform CalPERS and all of California’s pension systems

1 – Admit the long-term rate of return projection is too high for calculating the value of pension liabilities. Move it down to 6 percent. Increase the required “normal contribution” accordingly, and, in turn, increase the share required from active employees via withholding.

2 – Once a more reasonable long term rate of return projection is adopted by the pensions systems, the goal of pension reform should be to stabilize pension system payments at some maximum percent of total personnel costs. With cooperation from union leadership, agree on what that maximum percent should be, then determine how to spread benefit reductions in an equitable manner between new hires, current employees, and retirees.

3 – For all state and local government employee pension plans in California, start providing consolidated quarterly financial summaries (without gimmicks), using the above chart as an example. Include a footnote indicating how much of the total employer contribution is for the unfunded liability vs the normal contribution.

4 – If a pension system falls below 80 percent funded, agree on an escalating series of remedies to be implemented to bring the funded ratio back up. They would include suspension of COLA, prospective further lowering of the annual multiplier for active workers, retroactive lowering of the annual multiplier for active workers, reduction of the retiree pension payment, and increasing the required payment to the pension plan by active workers via withholding.

5 – Pressure the California State Supreme Court to swiftly hear and rule on the cases Alameda County Deputy Sheriff’s Ass’n. v. Alameda County Employees Retirement Ass’n (filed 1/8/2018), and Marin Ass’n of Pub. Employees v. Marin Cnty. Employees Retirement Ass’n (filed 8/17/2016). These cases may provide clarity on the “California Rule,” which currently is interpreted as prohibiting lower pension benefit accruals, even for future work.

6 – With or without a decisive ruling (or any ruling) on the California Rule, work with government union leadership to revise pension benefits. If union leadership is uncooperative and the courts fail to offer an enabling ruling, than as a last resort, to bring the unions back to the negotiating table, lower salaries, current benefits, and OPEB benefits.

7 – In the long run, move towards a system modeled after the federal system. This would be a logical next step, following in the footsteps of PEPRA. It would create three basic tiers of public sector workers in California, the pre-PEPRA workers (who may submit to lower benefit accruals for future work), the post-2013 hires who are subject to the PEPRA reforms, and new hires starting in, for example, 2021, who would enjoy retirement benefits similar to what Federal employees receive.

The Ripple Effect of Unreformed Pensions

There are two problems with a bullish outlook today. First of all, the great returns of the past few years may have been unsustainable, a super bubble. And then that super bubble was not popped by a pin, but rather by a wreaking ball, the Coronapocalypse. There are tough economic times ahead.

In a severe downturn it is conceivable that annual taxpayer contributions to California’s public employee pensions systems will not merely soar from around $50 billion in 2020 to $60 or $70 billion within a few years. They could go even higher. For example, over the total three year period through June 2020, it is quite possible that CalPERS will collect more from taxpayers – $65 billion – than it will have earned in investment returns – $52 billion.

This is the new reality of public sector pensions in California. And because taxpayers have been increasingly on the hook to bailout these pensions, taxes have increased, services have been cut, and there has been a gradual wearing away of trust by citizens in their local governments. This is why, for the first time in decades, more local taxes and bonds were rejected by voters in March 2020 than were approved. Absent pension reform, this backlash has just begun.

So-called “crowding out” of other public services in order to pay for pensions doesn’t just impel an insatiable drive for higher taxes. It also works its way into higher fees, building fees in particular. Infrastructure investments such as connector roads and parks for new housing subdivisions used to come largely out of municipal operating budgets. It was a fair trade – the city builds the roads, the builders sell the homes, and the new residents pay taxes. But now, all of those costs are paid for by the builders and passed on to the home buyers. The rising cost of pensions can be directly tied to the unaffordable cost of homes.

Pensions for state and local government employees in California are literally three to five times as costly as Social Security, and at least twice as costly as the Federal Retirement System. Ultimately, this disparity divides Americans and undermines what it means to be an American citizen. Why should public employees care if Social Security is inadequate, if they don’t depend on it? Why should they care if all public benefits offered private taxpayers is diluted, or if citizenship itself becomes less meaningful, if their membership within the public sector is the primary source of their security?

America is entering difficult economic times. Maybe one good thing to come out of this will be a willingness on the part of public sector union leadership to make common cause with all of California’s workers, and agree to reasonable concessions on pensions that will help everyone living in this great state.

This article originally appeared on the website California Globe.

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The Cost to Taxpayers of Enhancing Sonoma County Employee Pensions

In the early 2000s, along with many other cities, state agencies, and counties in California, Sonoma County enhanced their employee pension benefits.

As of 6/30/2018, Sonoma County’s pension system had $2.7 billion of invested assets, but nearly $3.1 billion in actuarial accrued liabilities. To what extent is its $400 million unfunded liability attributable to the pension benefit enhancements? Put another way, how much have these enhancements cost Sonoma County’s taxpayers?

Just as it is impossible to know with perfect accuracy the amount of a pension fund’s actuarial accrued liability, it is impossible to precisely calculate the cost to taxpayers of Sonoma County’s pension benefit enhancements. There is enough data available in the financial statements provided by Sonoma County’s pension fund, however, to provide credible estimates.

To improve the credibility of these estimates, the assumptions made herein are designed to understate the costs. For example, the impact of the increased cost is not assessed until the year the enhancements were fully implemented. In the case of general Sonoma County employees, that was 2005, and in the case of public safety employees of Sonoma County, that was 2006.

Sonoma County’s original pension benefits were based on the typical annual percentage accrual, multiplied by years worked, with the total percentage multiplied by the final pension eligible salary to calculate the retirement pension. For example, up until 2005, Sonoma County’s general (non-safety) workers would accrue their pension benefit at a rate of 2 percent per year. An employee who worked 30 years would have a pension equivalent to 60 percent of their final salary (2 percent times 30 years). As of 2005, that percentage was raised to 3 percent, and the age of eligibility to receive a full pension was increased from 57 to 60.

For public safety employees, the increase was even more dramatic, because not only did the annual percentage accrual increase from 2 percent to 3 percent, but the age of eligibility was lowered, from 55 to 50.

By assuming a typical case for a Sonoma County general employee, and another for a Sonoma County safety employee – before and after the pension benefit enhancement – it is possible to calculate the required annual contribution as a percent of payroll. The method to do this, along with all calculations related to this analysis, can be downloaded here.

Because the pension eligible payroll for Sonoma County since 2000 is disclosed in their Consolidated Annual Financial Reports (CAFRs), it is a simple matter to multiply these hypothetical contribution percentages by the actual payroll that was issued to Sonoma County employees. In this way, the differing costs – with or without the pension enhancements – can be calculated.

As it turns out, an employee working 30 years collecting a “2% @ 57” pension, retiring at age 60, requires an ongoing annual pension contribution equivalent to 14.7 percent of payroll. If that benefit is increased to a “3% @ 60” formula, the required contribution increases to 22.1 percent of payroll.

Similarly, for a safety employee working 30 years collecting a “2% @ 55” pension, retiring at age 55, requires an ongoing annual pension contribution equivalent to 16.8 percent of payroll. If that benefit is increased to a “3% @ 50” formula, the required contribution increases to 25.2 percent of payroll.

Using this method, between 2005 and 2018, if Sonoma County had not enhanced their pension benefits, they would have needed to contribute a total of $686 million to their pension system. Taking into account the cost of the benefit enhancements, they would have needed to contribute $1.02 billion to their pension system. This suggests that at the least, the pension benefit enhancements enacted by Sonoma County cost their taxpayers $331 million over the course of 14 years.

This is a very low estimate, however, for the following reasons.

1 – Sonoma County didn’t increase the value of their pension benefit accrual just for work yet to be performed. They increased the value retroactively. This has profound financial consequences. Employees who were nearing the ends of their careers suddenly had their pension benefits increased by 50 percent, from 2 percent, times the years they worked, to 3 percent, times the years they worked. But no extra money had been set aside for this over all the years prior to the enhancement. Sonoma County’s taxpayers had to make up that shortfall in the years after 2005.

2 – The shortfall, or unfunded liability, caused by the retroactive increase was itself a source of increased costs, because of the cost of not having those assets earning interest. While Sonoma County issued a $289 million pension obligation bond in 2010, there were the interest costs on the unfunded liability prior to 2010, plus the new source of interest expense required for the County to pay off this new bond. Moreover, even after this pension obligation bond was issued, at the end of 2010 the pension system’s unfunded liability still stood at $249 million (down from $402 million the year before).

3 – Sonoma County projects a long-term annual rate of return for its pension fund of 7.25 percent. But according to their latest CAFR, for the last 20 years, they have only managed to earn an average of 6 percent per year. This lower rate greatly increased the costs to fully fund the pension system. It also greatly increased the cost of the pension benefit enhancements.

To fully explore these additional variables is possible, but beyond the scope of a preliminary summary of the impact. But the baseline estimate, plus accounting for these additional factors, makes it virtually certain that Sonoma County’s pension benefit enhancements cost their taxpayers at least a half-billion dollars over the past 15 years, with ongoing costs into the future.

This article originally appeared on the website of the California Policy Center.

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How Much Will YOUR City Pay CalPERS in a Down Economy?

When evaluating the financial challenges facing California’s state and local public employee pension funds, a compelling question to consider is just how much more will they demand from their clients in the next economic downturn?

It’s noteworthy that CalPERS still hasn’t issued their actuarial analyses for the period ending 6/30/2018, even though a year ago, the 6/30/2017 analyses were available. Could it be related to the fact that the DJIA index on 10/01/2018 was 26,447 and as of midday 10/01/2019 it sits at 26,599? Between 6/30/2018 and 6/30/2019, did CalPERS have a bad year? And what does that mean?

What is alarming in the case of CalPERS and other public sector pension funds is the relentless and steep rate increases they’re already demanding from their participating employers. Equally alarming is the legal and political power CalPERS wields to force payment of these rate increases even after municipal bankruptcies where other long-term debt obligations are diminished if not completely washed away.

Until California’s local governments have the legal means to reform pension benefits, rising pension contributions represent an immutable, potentially unmanageable financial burden on them.

San Marino’s Payments to CalPERS Will Nearly Double by 2025

The City of San Marino, a small Southern California town with barely 13,000 residents, nonetheless offers a typical case study on the impact growing pension costs have on public services and local taxes. Using CalPERS own records and official projections, the City of San Marino paid $3.0 million (not including employee contributions) to CalPERS in their fiscal year ended 6/30/2017. That was equal to 32% of the base salary payments made in that year. By 2025, the City of San Marino is projected to pay $5.1 million to CalPERS, equal to 46% of base pay.

Can the City of San Marino afford to pay an additional $2.1 million per year to CalPERS, on top of the $3.0 million per year they’re already paying? They probably can, but at the expense of either higher local taxes or reduced public services, or a combination of both. But the story doesn’t end there.

The primary reason required payments to CalPERS are nearly doubling over the next few years is because CalPERS was wrong in three critical estimates: how much their pension fund could earn, how much would be paid to retirees, and how much their client agencies had to pay to stay current or catch up. They could still be wrong.

Annual pension contributions are are split into two categories:

(1) How much future pension benefits were earned in the current year, and how much money must be set aside in this same year to earn interest and eventually be used to pay those benefits in the future? This is called the “normal contribution.”

(2) What is the present value of ALL outstanding future pension payments, earned in all prior years by all participants in the plan, active and retired, and by how much does that value, that liability, exceed the amount of money currently invested in the pension fund? That amount is the unfunded pension liability, and the amount set aside each year to eventually reduce that unfunded liability to zero is called the “unfunded contribution,” or, in plain English, the catch-up payment.

Both of these annual pension contributions depend on a key assumption: What rate-of-return will the pension fund earn each year, on average, over the next several decades? And it turns out the amount that has to be paid each year to keep a pension system fully funded is extremely sensitive to this assumption. The reason, for example, that CalPERS is doubling the amount their participating employers have to pay each year is largely because they are gradually lowering their assumed rate of return from 7.5% per year to 7.0% per year. But what if that isn’t enough?

If the Rate-of-Return CalPERS Earns Falls, Payments Could Rise Much Higher

It isn’t unreasonable to worry that going forward, the average rate of return CalPERS earns on their investments could fall below 7.0% per year. For about a decade, nearly every asset class available to investors has enjoyed rates of appreciation in excess of historical averages. Yet despite being at what may be the late stages of a prolonged bull market in equities, bonds, and real estate, the City of San Marino’s pension investments managed by CalPERS were only 74% funded. As of 6/30/2017 (still the most recent data CalPERS currently offers by agency), the City of San Marino faced an unfunded pension liability of $29 million.

As it is, using CalPERS own estimates, by 2025 the City of San Marino is already going to be making an unfunded contribution that is nearly twice their normal contribution. Another reason for this is because CalPERS is now requiring their participating agencies to pay off their unfunded pension liabilities in 20 years of even payments. Previously, in an attempt to minimize those payments, agencies had been using 30 year payoff terms with low payments in the early years.

Nobody knows what the future holds. The following chart shows how that might play out in the City of San Marino. Notice how at a 4% rate-of-return projection, in 2018-19 the City of San Marino would have had to pay CalPERS $10.1 million; at 3%, $11.8 million.

San Marino is a wealthy community. The median household income of $147,960 is more than twice the median for California of $67,739 (ref. City-Data.com, figures for 2016). But with total municipal expenses of $26.2 million in the fiscal year ended 6/30/2017 (ref. San Marino CAFR, page 10), even San Marino’s budget can be stressed by pension expenses. CalPERS has projected the city’s pension contribution will rise to $5.1 million by 2025, which is 19 percent of total expenses.

At what point do these payments become too burdensome? What if investment returns settle down to an average of only 6 percent per year – can San Marino afford to pay CalPERS the resulting estimate of $7.0 million per year? What about at an even lower 5 percent return – can San Marino afford to pay CalPERS an estimated $8.5 million per year? And what about the employees? Will they start to pay more via payroll withholding? In 2017-18, employees only contributed $767,000 out of $3.8 million.

What about the rest of California?

How would a downturn affect all of California’s public employee pension systems, the agencies they serve, and the taxpayers who fund them? In a CPC analysis published in 2018, “How to Assess Impact of a Market Correction on Pension Payments,” the following excerpt provides an estimate:

“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.”

That’s a lot of billions. And as already noted, a 15% drop in the value of invested assets and a reduction in the estimated average annual rate-of-return from 7.0% to 6.0% is by no means a worst case scenario.

To-date, meaningful pension reform has been thwarted by powerful special interests, most notably pension systems and public sector unions, but also many financial sector firms who profit from the status quo. Ongoing court challenges, along with growing public pressure on local elected officials, may eventually offer relief. For these reasons, raising taxes and cutting services in order to fund pensions may eventually become a false choice.

This article originally appeared on the website of the California Policy Center.

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REFERENCES

CalPERS Annual Valuation Reports – main search page
CalPERS Annual Valuation Report – San Marino, Miscellaneous Employees
CalPERS Annual Valuation Report – San Marino, Miscellaneous, Second Tier
CalPERS Annual Valuation Report – San Marino, Miscellaneous Employees (PEPRA)
CalPERS Annual Valuation Report – San Marino, Safety Employees, Fire, Second Tier (PEPRA)
CalPERS Annual Valuation Report – San Marino, Safety Employees, Police (PEPRA)
CalPERS Annual Valuation Report – San Marino, Safety Employees, Fire, First Tier
CalPERS Annual Valuation Report – San Marino, Safety Employees, Fire, Second Tier
CalPERS Annual Valuation Report – San Marino, Safety Employees, Police
CalPERS Annual Valuation Report – San Marino, Safety Employees, Police, Second Tier

Moody’s Cross Sector Rating Methodology – Adjustments to US State and Local Government Reported Pension Data (version in effect 2018)

California Pension Tracker (Stanford Institute for Economic Policy Research – California Pension Tracker

Transparent California – main search page
Transparent California – salaries for San Marino, 2018
Transparent California – pensions for San Marino 2018

The State Controller’s Government Compensation in California – main search page
The State Controller’s Government Compensation in California – San Marino payroll, 2018
The State Controller’s Government Compensation in California – raw data downloads

California Policy Center – Resources for Pension Reformers (dozens of links)
California Policy Center – Will the California Supreme Court Reform the “California Rule?” (latest update)

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City of Richmond Faces Pension Stress

Pick a city in California. Pick a county in California. Odds are, they could be the topic of this analysis instead of Richmond. But Richmond is the focus of a recent analysis published in Reason entitled “Richmond, California’s Finances Remain Shaky,” and that work provides solid data from which to take a deeper look at what’s truly driving their financial challenges: compensation and pensions.

To summarize the Reason analysis, their most recent financial statements include the following excerpt from the auditor’s comments: “If deficit spending continues in the funds that continue to borrow from the General Fund and other funds, it reduces the likelihood that the City will be able to continue as a going concern.”

In plain English, what the auditor is saying is that the City of Richmond is spending more than they’re taking in, and they’re at risk of running out of cash. Reason’s senior policy analyst and the author of the report, Marc Joffe, writes: “Richmond’s unrestricted general fund balance of $18 million is small relative to general fund expenditures of $157 million. The ratio of 9% compares unfavorably to the 17% level recommended by the Government Finance Officers’ Association.”

Where is the money going? Compensation and pensions. Using raw data readily available from the California Office of the State Controller, in 2018 Richmond paid $121 million in base pay, overtime, other wages, health benefits and pension fund contributions. This represents 77 percent of their general fund expenditures.

When that percentage of a city’s budget is going towards pay and benefits, there are only a few ways to recover from deficits. One is to cut positions, which is what Richmond’s outgoing city manager, Carlos Martinez, suggested in a proposal that cost him his job.

According to John Geluardi, writing for the East Bay Express, “The firing was driven by the city’s five unions, which were angry with Martinez over negotiations and alleged labor law violations. In the past two or three weeks, union leaders put heavy pressure on councilmembers to oust the city manager. But Martinez was facing a $7 million budget deficit, which he inherited.”

To cover that deficit, as reported in the East Bay Times, Martinez had “identified a $7.6 million shortfall in fiscal year 2019-20, and identified 12 positions to be cut in order to make up for it. Martinez said they were upper management positions, not rank and file.”

The Times article also quoted Detective Ben Therriault, head of the Richmond Police Officers Association, saying that “The labor relations in the city have come to a collapse. For the past 10 months, labor has been worse than it has been in the past 10 years.” But how will the City of Richmond pay the bills?

Raising taxes is always the favored option of California’s local governments. In November 2018, 259 local agencies put tax increases onto the ballot in California and over 70 percent of them were approved by voters. Maybe new taxes will rescue Richmond’s finances. But do Richmond residents deserve to pay higher local taxes – sales tax, parcel tax, business licence tax, transient occupancy tax, utility user tax, gross receipts tax, etc.?

Richmond is not a wealthy city. The average per capita income in 2016 was $26,238; the average household income was $61,814. The average pay and benefits for a full time employee in the City of Richmond in 2018 was $181,444. These figures were arrived at using raw payroll data submitted by the City of Richmond to the California Office of the State Controller. Readers are welcome to download the spreadsheet showing the calculations. Perhaps there are errors, and if so, contact CPC and we will publish a retraction. Because these figures are literally unbelievable.

Unlike most cities and counties in California, moreover, there doesn’t appear to be a significant difference in compensation between public safety employees and the city bureaucrats. The average total pay and benefits for the 223 city bureaucrats identified as full time employees in 2018 was $182,772. For the police, $168,576, and for the firefighters, an astonishing $212,219.

Something that has always been inexplicable is why police get less in compensation than firefighters. This disparity is evident in most California cities and counties, and is in conflict with market realities as well as common sense. It is always difficult to recruit police officers, whereas when firefighting positions open there are always hundreds, if not thousands of applicants. And common sense, backed up by national statistics, shows that while police work and firefighting are both dangerous professions, they carry roughly equal risk.

The solution to this disparity, however, is not for police officers to make more. It is for firefighters to make less. If the 97 firefighters identified in 2018 as working full time for Richmond were paid $168,576 per year – equal to what Richmond’s police were paid, it would save the city $4.2 million per year, which would go a long way towards solving their budget deficit. Perhaps then Martinez would have only had to cut a half-dozen high ranking bureaucrat positions to balance the budget.

We may dream on. But some solution that remains within the realm of fantasy today will become hard reality tomorrow. Because Richmond’s financial problems are just beginning. Using projections provided by CalPERS for the City of Richmond, that city’s pension contribution is going to rise from $31 million in the fiscal year just ended to over $49 million by 2024. And that’s the low number. If the market “corrects,” Richmond will have to throw even more money into CalPERS’s insatiable maw.

While it may be harsh to suggest firefighters take pay cuts, it’s also necessary to explain that restoring parity to police and firefighter pay cannot possibly be afforded via increasing police pay. The money is not there. If equitable parity is to exist between these two noble professions, unfortunately, firefighter pay will have to come down.

It is impossible to overstate the appreciation most people feel for public safety professionals, certainly including firefighters. The same cannot be said for the leadership of the firefighters union. Over the past 20 years or longer, why didn’t the firefighters union leadership help stand up to the extreme environmentalist lobby, so legislation could have been passed allowing public agencies and private landowners to thin the forests? Why didn’t they fight for better wildland management, allowing for more controlled burns?

Instead, earlier this year, Harold Schaitberger, head of the International Association of Firefighters, marched in the streets with the United Teachers of Los Angeles – a radical leftist mob bent on destroying life as we know it. Perhaps it’s time for a long overdue grassroots insurgency by the center-right membership of public safety unions, so they can overthrow their “comrades” in charge.

Meanwhile, unions and management need to sit down in Richmond, and elsewhere, and talk about how to lower the cost of living for everyone, instead of always pushing for more, more, more.

This article originally appeared on the website of the California Policy Center.

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Were Pension Benefits Enhanced Without Due Process?

In 1999, at the height of the stock market runup fueled by the internet bubble, California’s state legislature passed SB 400, which increased pension benefits for officers with the California Highway Patrol. Over the next several years, pension benefits were similarly increased for government employees working in nearly every one of California’s cities, counties, state agencies, schools and special districts. But in California’s wine country, a case is quietly moving forward that argues these pension benefits were enhanced without due process.

The case, George Luke vs Sonoma County, is based on California Government Code Section 7507, which prohibits adoption of retirement benefit plan increases unless the approving agency first (1) retains an enrolled actuary, (2) who prepares an actuarial report, (3) which estimates future annual costs of the increases, and (4) the estimate of future annual costs are made available to the public at a meeting at least two weeks before the agency approves the increases.

The lawsuit was originally filed in 2017 and dismissed the following year by a trial court judge who said it didn’t meet statute of limitation requirements. But in his initial appeal, Luke is arguing that his claim isn’t barred by the statute of limitations since his taxpayer dollars are still going toward the increased benefits.

This week the most recent development in this appeal is a reply brief filed with the first appellate district court which argues “the judgement of dismissal must be reversed because the lower court misapplied the doctrine of continuous accrual.” The plaintiffs argue that the legal doctrine of continuous accrual means that each time pension benefits are recalculated – which would be every time the County makes a pension payment – the clock is reset on the statute of limitations.

Pension reform activists throughout California may wish to read “A New Approach to Pension Reform – How to Prepare,” written by Sonoma County pension activist Ken Churchill in March, 2019. This article explains in plain English how California Government Code Section 7507 may have been violated by agencies that granted pension benefit enhancements between 1999 and around 2006. The article also presents step-by-step instructions for anyone wishing to investigate this possibility in their city or county, both in terms of how to look for statutory violations, and in terms of what specific public records can be requested to document possible violations.

Pension reform activists also may wish to have expert legal review of the most recent appellant’s reply brief, which can be downloaded here.

The stakes could hardly be higher. Pension funds in California, despite a runup in the value of investments in stocks, real estate, and bonds, that has lasted for over a decade, are only about 70 percent funded. Even now, as the inevitable end of a prolonged bull market draws nigh, CalPERS and the other major California public employee pension systems have only lowered their projected average annual return percentage to 7 percent. Even if they achieve that rate over the next several years, CalPERS has already announced that most of their client agencies will need to nearly double their annual employer contribution rates over the next five years, mostly to pay off the huge unfunded liability associated with being only 70 percent funded.

The impact of the pension benefit enhancements that began in 1999 cannot be easily overstated. A typical pension benefit is based on the following formula: Years worked, times annual salary paid in final full year of employment, times a percentage “multiplier.” Back in 1999, for example, a California Highway Patrol Officer typically had a pension formula based on a multiplier of 2.0 percent. That is, when they retired after, say, 30 years of work, their pension would be calculated based on their final salary, times 30 times 2.0 percent, i.e., their pension would be equal to 60 percent of their final salary.

If that were all there were to that revision, one would expect that for years prior to 1999, the retiree’s multiplier would remain 2.0 percent, and for years they worked after 1999, it would be set at the new 3.0 percent. But the revisions to pension formulas went well beyond increasing the multiplier by 50 percent for years of work in the future. These multipliers were changed retroactively, meaning that the new higher multiplier applied to past years of work as well. In practice, this meant that for someone who worked 30 years and was retiring in 2000, one year after the benefits were enhanced, they would get 90 percent of their final salary as a pension, instead of 61 percent (29 x 20% + 1 x 3.0%).

It gets worse. These pension benefit revisions also lowered the age at which a retiree is eligible for full pension benefits from 55 to 50. A recent analysis by Ken Churchill, looking at the impact of these changes in Sonoma County, found that for public safety employees, the average age of retirement fell from 57 prior to the pension benefit enhancements to only 52 after the increase. This compounds the impact of enhancing pension benefits. Lowering the age of eligibility to receive a pension didn’t just happen in Sonoma County, it happened almost everywhere. Receiving pension benefits, on average, five years sooner, not only increases the amount of the lifetime pension payments by five years worth of payments, it also lowers the amount of pension contributions into the fund by five fewer years of work.

Beginning especially around 2009 when markets around the world endured a severe downward correction, pension activists have succeeded in making pension reform a recurring topic for policymakers. But undoing the financial damage caused by the wave of benefit increases that swept through California’s public agencies between 1999 and 2006 has proven very difficult.

In 2013, the PEPRA (Public Employee Pension Reform Act) legislation restored pension benefits for new hires back down closer to pre 1999 levels. But the so-called “California Rule,” an interpretation of California contract law that has prevailed thus far in court battles, has prevented changing pension benefit multipliers, even if only for future work. The moral justification for this escapes a lay observer, insofar as multipliers were increased not just for future work, but retroactively.

The ongoing litigation on the issue of failure to notify the public of the future annual cost as required by Government Code Section 7507 violations of due process may provide another avenue on which to apply pressure for meaningful pension reform. Defined benefit pensions, when they are based on reasonable multipliers and conservative rate of return assumptions, can remain a financially sustainable way to provide retirement security to public servants.

This article originally appeared on the website of the California Policy Center.

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City of Oxnard Pension Contributions Set to Double by 2024

As reported by the Ventura County Star, the City of Oxnard faces budget headwinds. Quoted in the article, Mayor Tim Flynn had this to say:

“We’re making decisions that should have been made 10, 20 years ago to put the city on a sustainable path,” Flynn said. “These are very painful cuts, but we have to live within our means. The city historically has not lived within our means.”

City Manager Alex Nguyen was more specific:

“Skyrocketing pension costs and spikes in health care are some of the reasons for the budget shortfall. With projected expenditures approximately $10 million more than anticipated revenue, there is no choice but to recommend programmatic cuts to the City Council.”

Skyrocketing pension costs. You can say that again. Depicted on the chart below is a summary of what’s happening to Oxnard, thanks to “skyrocketing pension costs.” The biggest takeaway from this chart is the fact that Oxnard’s pensions have just begun to “skyrocket.” If you want to skip the details and cut to the chase, view the yellow highlighted figures in the middle and at the bottom of the right column.

The first highlighted numbers show how much Oxnard had to pay CalPERS (not including employee contributions through withholding) back in 2017. Back then, it cost them $23 million. Now look to the bottom of the chart, to see what these pensions are going to cost the city in 2024 – nearly twice as much at over $45 million.

The numbers on this chart were taken directly from CalPERS “Public Agency Valuation Reports,” in this case, for the four participating employee units (miscellaneous, “PEPRA” firefighters, firefighters, and police). The fifth column is merely the sum of the first four. The only numbers which had to be inferred were the payrolls for the two firefighter units, since, inexplicably, CalPERS didn’t provide those numbers. But they were simply escalated at the same moderate rate that CalPERS had used for the miscellaneous and police units.

The numbers on this chart provide a lot of sobering information. Oxnard’s pension costs are going to increase from 27 percent of payroll in 2017 to 44 percent of payroll by 2024. In actual dollars, as noted, the payments will double. It is critical to understand as well that these estimates from CalPERS do not take into account a slowdown in investment returns. If that happens, the increases could be much higher.

Something always important to point out is that most of the increase in Oxnard’s payments is to increase the so-called “unfunded contribution” – these are the catch-up payments pension system clients have to make to reduce their unfunded liability. Note (right column, just above the first set of yellow highlighted numbers) that in 2016-17 the “normal contribution” was $11.8 million and the “unfunded pension contribution” was slightly less, at $11.6 million. Then skip to the numbers just above the lower set of highlighted numbers, to see these amounts projected for 2024-25. The normal contribution is up sharply, increasing 43 percent to $16.9 million, but the unfunded pension contribution is up 150 percent, to $28.7 million. There’s a reason for this.

For years, the unfunded liability of pension funds, everywhere in California, grew faster than they were being paid down. Overly optimistic rates of return and “creative” repayment schemes (remember the negative amortization mortgages?) caused this, and everyone looked the other way. Budget directors and councilmembers accepted creative accounting gimmicks because they didn’t have enough money in their budget to pay any more to CalPERS than they absolutely had to. Union leadership knew that pension reforms only required employees to increase their payments (through payroll withholding) on the normal contribution, and that the unfunded contribution was the sole responsibility of the taxpayer.

Oxnard’s dilemma is not unique. Every city and county in California, with rare exceptions, is coming to terms with this crisis. But will Oxnard renegotiate pensions, that third rail of public employee entitlement? PEPRA, while helpful, only applies to new hires and will take decades to have an impact. Reform via lowering of pension benefit accruals just for future work has been struck down repeatedly in court, even though it was just fine when pension benefits were enhanced retroactively for past work. As for bankruptcy? Why bother? Wherever that’s been tried – Vallejo and Stockton come to mind – the bond investors got tanked and the pensions were untouched.

Oxnard, like every other city and county in California, will continue to raise taxes and cut services to make their pension payments. But have a look at the salaries and benefits that Oxnard’s unionized public employees receive. Have a look at the pensions Oxnard’s retirees are collecting. And on top of that, ask whether or not city’s planned “painful cuts” will include cutting their supplemental retirement plan administered by PARS. This is discussed on page 108 of the city’s most recent financial report. The supplement creates an unusual 3% at 60 benefit formula for miscellaneous (i.e., non-safety) employees. Because the pensions they’re getting, which average more than most Californians in the private sector make while working full time, are not enough.

Where’s the moral outrage?

It is time for a state ballot initiative to revise the state constitution to permit real, lasting, financially sustainable pension reform.

This article originally appeared on the website of the California Policy Center.

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Why is San Diego’s Pension Settlement Estimate So Much Money?

In 2012, San Diego voters approved Proposition B, a pension reform measure that replaced pensions for new hires with a 401K plan. Seven years later, it is possible this reform will be completely unwound, because union attorneys have successfully argued that the city didn’t “meet and confer” with the unions before putting the reform measure on the ballot for voter approval.

As reported two weeks ago, the U.S. Supreme Court refused to hear the city’s argument that the San Diego’s mayor, who supported Prop. B, was exercising his right to free speech, and to force him to meet and confer with the unions prior to supporting Prop. B would have been a violation of that right.

Since then, the case has been returned to the original appellate court, which on 3/25 ruled that the city must “meet and confer over the effects of the initiative and to pay the affected current and former employees represented by the Unions the difference, plus seven percent annual interest, between the compensation, including retirement benefits, the employees would have received before the initiative became effective and the compensation the employees received after the initiative became effective.”

This ruling raises more questions as it answers. For example, does this ruling definitely require the city to pay those employees affected by Prop. B? This is unclear, because the next sentence of the ruling seems to offer the city a way out, by stating:

“The City’s obligation to comply with the compensatory remedy extends until completion of the bargaining process [the “meet and confer”]… …before placing a charter amendment on the ballot that is advanced by the City and affects employee pension benefits and and/or other negotiable subjects.”

In plain English, it appears the court has ordered the City of San Diego to meet and confer, then if an impasse is reached, to place an amended version of Prop. B in front of the voters. But this raises another question – did the City of San Diego really put Prop. B on the ballot, violating the meet and confer requirement?

The actual proponents of the measure, Steve Williams, TJ Zane, and April Boling, were private citizens. They put Prop. B on the ballot, and the funds used to qualify Prop. B and campaign for Prop. B were all privately sourced. San Diego’s mayor supported Prop. B, but only did so after these private parties had announced their campaign. Prop. B would have been put before voters, and likely passed, with or without support from the mayor.

For this reason, if and when a settlement is reached between the City of San Diego and the unions, a lawsuit will be filed on behalf of the true proponents, arguing that there never was a “meet and confer” requirement, since the initiative originated outside of city hall. But how much money is really at stake?

While some of those close to the case maintain that estimating how much it would cost to “make whole” the employees affected by Prop. B is getting “into the weeds,” these might be very big weeds, or they may be insignificant weeds. Nobody seems to have any idea if these weeds are microscopic cilia, or Sequoiadendron giganteum.

Why Do News Reports Estimate Such A Huge Potential Liability to the City of San Diego?

According to a report in the San Diego Union Tribune, “Estimates of the city’s costs have ranged from $20 million to $100 million based on a variety of factors, but a precise estimate isn’t possible without a comprehensive actuarial analysis.” That’s quite a range of estimates, with a huge number of huge variables affecting the calculation. But possibly the biggest question is why are these estimates of the city’s costs so high? Three simple examples illustrate why this is a compelling question.

In all cases, the same basic assumptions apply. On the three charts below, these assumptions are highlighted in yellow. It is assumed that the 4,000 employees affected by Prop. B were hired over the past six years in equal increments, i.e., 667 new hires per year. It is assumed that their average 401K eligible (or pension eligible) salary is $70,000 per year. It is also assumed that the amount the city contributed into a 401K on behalf of these employees was the same as the amount they would have contributed into the pension fund. More on that later. For these examples, that contribution is assumed to be nine percent.

As can be seen in the first case, if you assume that the annual earnings percent for the 401K fund is equal to the amount earned by the pension fund, seven percent per year, than the amount by which the pension fund balance would exceed the 401K fund balance is zero. The next two cases show the financial impact if these earnings percentages differ.

As can be seen in the second case, below, if the 401K fund outperforms the pension fund, by earning ten percent per year compared to a fixed seven percent, which the pension fund uses as its long-term average annual return for actuarial purposes, then the impact of Prop. B on the affected employees is actually positive, with the City of San Diego in a position of having overcompensated these employees by giving them a 401K plan.

In the third case, it is assumed the pension fund, earning seven percent per year, has outperformed the 401K fund, which is only assumed to have earned four percent per year. Since it is typically an option for 401K plan participants to select a low risk investment option, for many of the 401K participants this may have occurred. But as can be seen on the chart below, even if every one of the 4,000 new employees selected this option, the city’s liability would only total around $6.5 million.

Reviewing these three cases, it begs the question: Where are analysts coming up with a “$20 to $100 million” estimate of potential costs to the City of San Diego to move these 4,000 employees from a 401K plan onto a pension plan, or goose their 401K plan to make it equal to the value of the pension benefits they would have accrued by now? Certain things can be ruled out.

For example, you can rule out the possibility that the pension eligible salary estimate of $70,000 is too low. Because even if it were much higher, say $100,000 on average, that would only increase the amount of the liability by 30 percent. Similarly, you can rule out the timing of these hires as a critical variable, because even if you hired two-thirds of them in the first three years, instead of only half of them in the first three years, you would only increase the liability in Case Three (pension fund outperforming 410K) from $6.5 million to $8.0 million.

This leaves two critical variables that must account for the high estimates for the city’s potential liability, the annual earnings percent, or the percent of salary paid into either the pension fund or the 401K plan. The annual earnings percent can be ruled out immediately, because while the pension fund experiences earnings that vary widely from year to year, they rely on a long-term average rate-of-return that rarely changes. When these earnings assumptions do change, they change very little. It would be interesting to see how one might argue that the extraordinary returns the pension fund may have realized during 2017, when the stock market exploded, would have to be taken into account, since only the long-term average rate-of-return assumption is relevant to actuarial valuations and determining contribution amounts. And in any case, 401K plans also saw their values explode in 2017, probably cancelling out that effect. Which leaves only one variable for consideration – the percent paid into the pension fund. And this is THE critical variable.

Here you can come up with extraordinary numbers indeed. For example the City of San Diego currently pays 72 percent of pension eligible payroll (SD CAFR, page 192) into their pension fund. And if you plug that number into Case One, leaving every other assumption unchanged, the cost to “make whole” these 4,000 new hires affected by Prop. B is $719 million. Clearly, the entire substance of the “meet and confer” just mandated by the appellate court will focus on what this contribution should have been. And that’s worth a few more thoughts, because there’s a reason the contribution percentage is an outrageous 72 percent.

As reported two weeks ago, and as documented in the 2018 financial report for San Diego’s pension fund (SDCERS CAFR page 91), the city’s pension fund liabilities exceed its assets by $2.8 billion. This means that most of the payments the city is making to their pension fund is to catch up after falling so far behind. But should new employees have these catch up payments considered part of their pension benefit? This brings up interesting contradictions.

First of all, every new employee’s individual pension benefit is, theoretically, kept fully funded merely by making the so-called “normal contribution.” That is the amount that has to be invested in the pension fund in, for example, 2018, to earn interest over time so there will eventually be enough money to pay for the amount of future retirement benefit that was earned in 2018. How much are these “normal contributions” as a percent of payroll? Typically they aren’t very much, which is why the pension plans fell behind. They also fell behind, way behind, when pension benefits for City of San Diego employees were retroactively enhanced, back in the early 2000s. But is any of that the fault (or the benefit) of the new hires? Of course not.

There’s a lot of hypocrisy at work here. The higher the rate-of-return assumption, logically, the lower the normal contribution, since less money has to be contributed each year if you think that money is going to earn more in interest over time. And since public employees typically have to pay a share of their normal contribution via withholding, their unions have used their influence on the pension fund boards to keep that interest rate assumption higher than it might otherwise be. Another glaring, albeit abstruse hypocrisy is the fact that whenever watchdog organizations call attention to the lavish “total compensation” averages for public employees, amounts that are invariably elevated based on huge per employee “catch up” contributions to the pension funds, the union spokespeople counter with the argument that these catch up, or “unfunded contributions” shouldn’t be included. Fair enough. Then they should not be included in any settlement agreement, either.

Which brings us to the final question: What is a reasonable “normal contribution” to San Diego’s pension plan for the 4,000 mostly miscellaneous employees (police were exempt) affected by Prop. B? Is nine percent per year sufficient? And if so, then why are we talking about a settlement estimate in the tens of millions, instead of mere millions?

This article originally appeared on the website of the California Policy Center

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