Tag Archive for: pension reform

San Diego’s 2012 Pension Reform at Risk

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“The ruling is also an implicit endorsement of the state Public Employment Relations Board’s conclusion that the employees hired since the measure took effect must be made whole and get a pension equivalent to what they would have received pre-Proposition B.”
– Editorial, San Diego Union Tribune, March 18, 2019

The ruling in question is the California’s Supreme Court’s August 2018 decision which found that “San Diego’s six-year-old pension cutbacks were not legally placed on the ballot because city officials failed to negotiate with labor unions before pursuing the measure.” It’s in the news again this week because the U.S. Supreme Court has just announced they will not hear the City’s appeal of the California ruling.

What’s going to happen now is uncertain. Back in 2012, a super-majority of San Diego voters, 65 percent, approved pension cuts for new employees, putting all but police hires onto 401K plans. The union immediately appealed, claiming that since one of the proponents of the ballot measure was the mayor, it was necessary to “meet and confer” with the unions before asking the voters to change the pension benefits that new employees would receive.

The trajectory of this case is complex. Back in 2012, the unions challenged the voter approved reforms before the union-stacked Public Employee Relations Board, which in 2015 ruled in their favor. Then the City of San Diego got PERB’s ruling overturned in 2017 in state appellate court. Which brings us to round three, back in August, won by the unions in the State Supreme Court. But opinions differ as to what will happen next.

As the San Diego Union-Tribune opined in their editorial, the State Supreme Court “implicitly endorsed” the PERB ruling that invalidates the voter approved reforms. But some of the original proponents disagree.

One of the attorneys who has represented the proponents, Kenneth Lounsberry, in an email, wrote, “The State Court didn’t need to “invite” a position on the validity issue, which was heavily briefed in the moving papers. If the high court wanted to invalidate the measure, it would have done so. It is likely, based on oral argument, that the Court of Appeal WILL NOT invalidate Prop B. The true remedy in this case is a process. The City, according to the State Court, should have met and conferred; abiding by the process. The remedy – make them meet and confer. But, do not speculate about the outcome – the result – of meeting an conferring. No one, least of all the Court of Appeal, needs to conjure a RESULT. The result will the product of painful and extended negotiations that must include a fiscal analysis of the potential outcomes. We’ll see if the unions have the stomach for urging municipal insolvency.”

Municipal insolvency indeed. More to the point, higher taxes for less service, thanks to pensions. Why else would two thirds of San Diego voters have supported this reform? Questioning the validity of Prop. B is based on an oversight that wouldn’t have changed the outcome. Would this have been challenged if the proponents hadn’t included the mayor? So what if the mayor was included as a proponent? What about free speech? The mayor can’t take a policy initiative to the voters? And so what if the mayor didn’t “meet and confer.” Would the outcome have been different? Of course not. The unions would have refused to accept the proposed reform, the “meet and confer” condition would have been met, the proponents would have gone on to place Prop. B on the ballot, and the voters would have approved it.

What kind of money are we talking about, anyway? If Prop. B is invalidated next month, as the case returns to the appellate court, the cost of “making whole” the 4,000 employees hired since pensions were eliminated is estimated to range between $20 and $100 million. The financial precedent going forward is likely more significant than the actual cost of catching up – $100 million could be financed at 6 percent for 20 years at $8.7 million per year. The pushers of pension obligation bonds would be happy to step up and take care of that for the city. With general fund revenues for 2019 estimated to be nearly $1.1 billion (SD CAFR, page 15), they can afford another $8.7 million. Or can they?

The City of San Diego’s financial statements for FY 2018 report pension payments of $325 million (SD CAFR, page 192), which is 72 percent of pension eligible payroll. Seventy two percent. To put this in perspective, private sector employers pay Social Security taxes equivalent to 6.2 percent of payroll, plus, in increasingly rare cases, maybe a 3.0 percent matching contribution to a 401K plan. Let’s review: Private sector employer contribution for retirement, up to 9.2 percent. Public sector (City of San Diego) employer contribution for retirement, 72 percent, eight times as much.

With all that money pouring into the City of San Diego’s independent pension system, how are they doing? Presented below is a chart from their 2018 financial report (SDCERS CAFR page 91) that shows their funding status. As can be seen, the size of the plan’s liability, which is the present estimated value of all promised future pension payments (vertical axis) has exploded, thanks to pension benefit enhancements enacted starting in the late 1990s. As can be seen, the pension liability was around $1.3 billion in 1995, and it grew to around $9.6 billion by 2017.

To be fair, the City of San Diego’s population grew by 22 percent between 1995 and 2017, and the consumer price index inflated by 61 percent. So normalizing for those factors, the pension liability should have increased by 96 percent, up to $2.5 billion. It’s 370 percent higher than that. We can thank the public employee unions, and their powerful accomplices, the pension fund lobbyists, for benefit enhancements that have piled nearly $10 billion of pension debt onto the taxpayers of San Diego. How much of that is covered by assets in the pension fund?

Again, the chart shows that trend. Back in 1995, the pension liability was 92.7 percent covered, that is, there was roughly $1.3 billion in liabilities, and roughly $1.2 billion in invested assets. What about 2017? How are they doing? As the chart indicates, only 71.2 percent, or about $6.8 billion, is available to cover $9.6 billion in pension liabilities. They are $2.8 billion in the hole.

Another way to put this all into perspective is to look at the actual pensions being paid by the City of San Diego. According to Transparent California, the average pension for a retiree with 30 years of full time work was $85,670 in 2017.

That average is skewed upwards to include DROP payments, an amazing boondoggle that San Diego offers along with many other California cities. The “Deferred Retirement Option Plan” (DROP), allows pension eligible employees to start collecting their pension (paid into an interest bearing account) while they continue to work. When they finally do retire, that lump sum is paid to them in their first year of retirement, along with the ongoing pension payments. Have a look at the City of San Diego’s individual pension payments courtesy of Transparent California. Wherever it says “see note” you can see how much DROP payments each of them collected. The 2017 champion is Diane Silva-Martinez, who collected a lump sum of $824,300 when she “actually” retired. Note most 2017 retirees receiving DROP payments probably weren’t retired the entire 12 months of 2017, so the imputed net amounts of their actual 2017 pensions are usually understated.

And if you don’t include DROP payments, how much does the average City of San Diego employee receive as a pension? The San Diego City Employees’ Retirement System financial report for FYE 6/30/2018 offers clues. Page 131 shows that in 2017 there were 9,768 retirees collecting an average pension of $48,199, based on an average retirement age of 56, and average “service years” of 24. On page 132 of the SDCERS financial report you can see retiree pensions sorted by years of service and final monthly salary. The average retiree with 26-30 years of service had an average salary of $82,728 and received a pension of $67,968. These pension averages don’t include other benefits such as retiree health care, but are these “modest” pensions? That depends on what you’re comparing it to. Social Security provides a good comparison, since that’s what the San Diego’s private sector taxpayers get.

If you go to the “Social Security Quick Calculator” and input an average final salary of $82,728, a retirement date of April, 2019, and a birth date of 1949 – which means you worked till the age of 70 – your estimated Social Security payment is $32,016 per year. That’s modest. A good rule of thumb when comparing Social Security to public sector pensions in California is “work twice as long, collect half as much.” And of course never forget that independent contractors pay 12.4 percent of their gross earnings into the Social Security fund. Examples of public employees who have 12.4 percent or more withheld from their paychecks are few and far between, if there are any at all.

How did it come to this? An excellent analysis of San Diego’s pension enhancements and the financial havoc they were creating was written in 2014 by Adam Summers and Lance Christensen and published by Reason. While five years old, the report nails the history, and deserves reading in its entirety by anyone wanting a more thorough understanding of what led up to the present situation. Here is a relevant excerpt:

“The average San Diego city employee’s pension more than tripled between 1996 and 2013. The average city pension for employees who had worked over 30 years was nearly $64,000 in 2012. The increase in retirement costs is due, in large part, to several lavish benefits—including a program for “double-dipping” (the Deferred Retirement Option Program (DROP), purchasing years of service that were not worked (“air time”), receiving extra pension checks, and employer-matching savings plans—added to an already generous retirement package.”

California’s public employee pensions are not sustainable. Moving new employees to 401K plans was a financially sound option because it put a cap on the city’s obligation. There are many ways to restore financial sustainability to California’s public employee pensions. Voters are likely to overwhelmingly support any of them. What happens next in San Diego bears watching.

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

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A New Approach to Pension Reform Goes to Appellate Court

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The recent ruling by the California Supreme Court in the case CalFire vs CalPERS has garnered much attention from pension reformers. While falling short of being a landmark ruling, the result was nonetheless encouraging. The court left open the possibility that vesting does not protect prospective benefits of current employees. The implications of that are left to related, still active court cases to decide.

Meanwhile, a completely different approach to pension reform has been hitting courts around California, centered on the argument that government agencies did not follow due process when approving pension enhancements. Between 1999 and 2007, one by one, nearly all of California’s government agencies enacted pension benefit increases of 50 percent or more. These increases were made retroactively, causing an actual financial impact well in excess of 50 percent. But when they did this, did they obey the law?

Three lawsuits have been filed by citizens taxpayers seeking to have pension increases overturned on the ground that they were adopted in violation of Section 7507, but each time, the trial court has dismissed the case on the ground that the lawsuit is barred by the three-year statute of limitations.

Convinced that the statute of limitations should not act as a bar to taxpayer claims to challenge these statutory violations, taxpayer/plaintiff George Luke raised the money to hire counsel, Robinson & Robinson LLP, to take an appeal from the statute of limitations ruling.  If Mr. Luke is successful, it will open the door to every agency, or their taxpayers, where pension increases were approved without complying with Section 7507 to either challenge those pension increases in court or to renegotiate them. The brief on appeal in the Luke case is available here.

The legal challenge claiming pension benefit enhancements were adopted without following due process 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 costs of the increases, and (4) the estimate of future costs are made available to the public at a meeting at least two weeks before the agency approves the increases. It is not clear that any of the several cities and counties that have been audited so far had complied with these requirements.

Local pension reform activists in California, along with local elected officials committed to pension reform, can request and copy archives from local agencies that documented the process they followed when they enhanced their pension benefits. That audit process can be summarized as follows:

(1) Find out whether your agency approved pension increases between 1999 and 2007.

(2) If so, obtain all documents pertaining to that approval as described below and ascertain whether the documents show compliance with Government Code Section 7507.

(3) If the documents do not reveal compliance, preserve copies of those documents. They will be important evidence if there is future litigation involving the pension increases.

(4) Contact the agency’s attorney to inform him or her of the non-compliance.

The California Policy Center has compiled a detailed set of instructions to assist elected officials, candidates, and taxpayers to determine whether their city or county pension system complied with the 7507 requirement when major increases in pension formulas were made between 1999 and 2007. That information can be found here.

California’s public employee pension systems are facing financial headwinds of growing strength. As of March 9th, America’s bull market in equities has lasted a record ten years. During the same time there has been a runup in real estate values that far exceeded the rate of inflation and is unsustainable. The long overdue rise in interest rates threatens the bond market. And yet, here on the tail end of one of the best decades for investors in history, California’s pension systems are only about 70 percent funded. When the markets slump, pension headwinds will turn into pension hurricanes.

To save pensions, it is a false choice to only offer tax increases and service cuts. Measured reductions to pension benefits accruals for future work – not even touching pension benefits already earned – will be an essential element of any successful strategy. Accomplishing this in court, when the politicians lack the will to do what must be done, may be the only avenue possible. George Luke’s appeal offers another path forward.

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

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California Rule Does Not Protect “Airtime”

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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California’s Government Worker Pensions Are Bankrupt

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As reported today in Capitol Weekly, in a post entitled “CalPERS ignores Brown, delays pension payment” by Ed Mendel, the amount taxpayers will have to fork over to CalPERS next year will rise by $213 million, to a total of $3.7 billion. Governor Brown, quite rightly, believes the full amount of the necessary increase should have been assessed, another $149 million, instead of being “smoothed” over the next twenty years.

But CalPERS – the largest of over 30 major government worker pension funds in California, only manages about a third of the the state and local public sector pensions. And CalPERS is basing their increase on a lowering of their projected rate of return for their invested funds by one quarter of one percent, from 7.75% down to 7.5%.

People may debate endlessly over whether or not government worker pension funds in America, now managing over $4.0 trillion in assets, can actually earn 7.5% per year, every year, for decades on end. We have argued repeatedly that this rate of return is impossible to achieve any longer, because (1) high returns in the past depended on debt accumulation, which poured cash into the economy, which stimulated consumer spending, investing, and asset appreciation – enabling more borrowing – all of which caused investment returns to grow at levels that cannot continue now that borrowing has reached its practical limit, (2) our aging population means more people will be selling their investments to finance their retirements – including the pension funds whose participants themselves are aging and are retiring with higher benefits than previous retirees – and this puts more sellers in the market, lowering asset values and returns on invested assets, and (3) pension funds are much larger as a percent of GDP than they were in previous decades, and they are now too big to consistently beat the market.

This debate will not go away. But it is at least worth examining just how much it will cost Californians if the rates of return on state and local government worker pension funds drops by 1.0%, 2.0%, or 3.0%. The fact is, they might drop by even more than that. Go to a commercial bank and try to buy a U.S. Treasury bill or certificate of deposit that pays 4.75%. Or examine the returns on the major stock exchanges over the past 10+ years. Yields are well under 4.75%, yet CalPERS has lowered their rate of return by only one-quarter of one percent to 7.5?

What are they scared of? Why not pick a risk-free, much lower rate of return?

The table below shows how much the annual pension contribution as a percent of payroll increases when the rate of return drops. Column one shows the contributions required under the original 7.75% long-term rate of return projection, which has just been lowered to 7.5%. Columns two, three and four show the contributions required under lower rates of return, 6.75%, 5.75%, and 4.75%. The rows show just how much these contributions need to be under various pension formulas. These formulas govern most government worker pensions – the percentage noted, “1.25% per year,” for example, means that if a government worker retires after 30 years, their pension will be calculated as follows: 1.25% x 30 x final salary, or in this case, 37.5% of final salary. The amounts selected for these rows are representative of the following pension formulas:

  • 1.25% per year  –  for typical non-safety employees up until around 2000.
  • 1.6% per year  –  the average of non-safety and safety employees up until around 2000.
  • 2.0% per year  –  for typical safety employees up until around 2000; for typical non-safety employees since then.
  • 2.5% per year  –  the average of non-safety and safety employees since around 2000.
  • 3.0% per year  –  for typical safety employees since around 2000.

On the table below, row four of the pension formulas, outlined, shows how lowered rates of return will impact the contributions necessary to fund a 2.5% per year formula. Since 2.5% per year is the blended average that would represent all current state and local government employees in California, the results in this row should be of great interest to taxpayers and public employees alike. As can be seen in this case, the annual pension contribution as a percent of payroll must increase from 16.3% at the rosy rate of return of 7.75% to 21.4% (at 6.75% return), to 28% (at 5.75% return), to 36.6% (at a still impressive 4.75% rate of return).

The table above concludes by taking these pension contributions and applying them to the total payroll of California’s state and local governments, which is (using conservative estimates) 1,500,000 employees times an average annual salary of $70,000 per year (ref. U.S. Census, 2010 CA State Gov. Payroll, and 2010 CA Local Gov. Payroll). As can be seen, if the rate of return for California’s state and local government employee pension funds drops from 7.75% to 6.75%, this will cost taxpayers another $5.4 billion per year. If the return projection drops to 5.75%, it will cost taxpayers another $12.3 billion per year. And if the return projection drops to 4.75% per year, it will cost taxpayers an additional $21.3 billion per year. But wait, because the above analysis still understates the problem.

There’s one more big gotcha.

The first table is entitled “Impact of Lowered Return Projections if we could Retroactively Increase Contributions.” But we can’t do that. Contributions that are in the funds currently were made under the assumption that the 7.75% rate of return would last forever. If we lower that assumption, we still have to fund our pension obligations by investing the money we’ve already got, plus whatever additional monies we can collect from now on. This severely compounds the problem.

The next table, below, calculates how much lowered return projections will cause pension contributions to increase, if half of the contributions are already made. This assumes that in aggregate, the participants in California’s government worker pensions are at mid-career. This is an extremely conservative assumption, because there are millions of government workers who are already retired, whose pension payments are equally dependent on investment returns from the pension funds. This next table therefore understates the impact of lower investment returns on the required contributions to the fund from existing workers.

As can be seen in this more realistic, but still very much a best case scenario, if the rate of return for California’s state and local government employee pension funds drops from 7.75% to 6.75%, this will cost taxpayers another $11.3 billion per year. If the return projection drops to 5.75%, it will cost taxpayers another $24.9 billion per year. And if the return projection drops to a still quite aggressive 4.75% per year, it will cost taxpayers an additional $40.8 billion per year.

This is what the pension funds are up against. These are the scenarios the pension bankers exchange in closed meetings, where the press and even their own PR people don’t attend. Imagine if CalPERS admitted, as they should, that their funds cannot reliably expect to earn more than 4.75% per year. It would mean that – assuming all 10 million of California’s households pay taxes, which obviously is not the case – that every household in the state would have to fork over another $4,000 per year in increased taxes.

Critics of pensions and critics of pension reform alike are invited to verify for themselves the calculations made here. To imply, as CalPERS has, that about another $1.0 billion per year, spread among the 30 California government worker pension funds and “smoothed” over the next 20 years, is all it will take to shore up their solvency, is irresponsible. The additional amount necessary to save California’s government worker pensions is probably closer to $40 billion per year, from now until these pension formulas are reduced.