Last week, the court issued its long-awaited decision in a court case involving a Sacramento local firefighters union that alleged a provision of the 2012 pension reform measure approved by the Legislature and signed by then-Gov. Jerry Brown was illegal under the “California Rule.” That’s the legal concept stemming from a 1955 state Supreme Court ruling that holds the terms of a public employee’s pension benefit cannot be reduced for years not yet worked, only kept the same or increased.

Cal Fire Local 2881 said that the pension reform’s ban on “air time” – the purchase of service credits to enhance pensions – violated the California Rule. But a unanimous state Supreme Court said “air time” was not a comprehensively bargained or legislatively approved vested right.

Yet in the lead opinion, Chief Justice Tani Cantil-Sakauye (pictured) explicitly said she was not taking a position on the California Rule question of whether pension terms could be changed going forward for years not worked.

This mixed message produced media confusion. Some news bulletins declared the justices had approved allowing a rollback of local benefits. Others suggested the California Rule had dodged a bullet.

Was ‘California Rule’ weakened or untouched?

Interest groups were similarly split.

Officials with the League of California Cities saw the court’s willingness to change the terms of pensions on a relatively minor issue as a sign it was open to a significant weakening of the California Rule. The league and many like groups hope for a state Supreme Court ruling that echoes a lower court’s ruling that pensions are not “immutable.” They were heartened by Cantil-Sakauye specifically noting the state had raised the retirement age from 67 to 70 for current as well as prospective employees.

But the Californians for Retirement Security, which represents 1.6 million public employees and former public employees, declared victory after noting that Cantil-Sakauye had specifically said “air time” was changeable because it was not a vested right – unlike basic pension formulas basing retirement checks on years worked times a percent of late-career salary.

The group and others also cited a concurring opinion written by Justice Leondra Kruger and joined by Justice Goodwin Liu that held that government employers could not “withdraw” from the pension terms established upon initial employment by “an implied unilateral contract.”

The state Supreme Court is expected to eventually take up at least two more cases involving union objections to the 2012 pension reform, so the sanctity and extent of the California Rule is likely to remain in the news. In his final year in office, Gov. Jerry Brown repeatedly urged the court to give governments the option to change future pension terms as pension costs have crowded out local, county and school programs and services. Brown’s office defended the 2012 reform law before the high court because of concern that state Attorney General Xavier Becerra was not eager to defend it.

Like 2017 case, ruling seen as murky, not clarifying

But in the meantime, last week’s ruling seems as murky as the court’s decision in the 2017 California Cannabis Coalition v. City of Upland case. Previously, Proposition 218, approved by voters in 1996, had been understood to require that any tax whose revenue would go to a special purpose – building a sports arena, adding libraries, etc. – had to be approved by a two-thirds vote.

Upending decades of precedent, the state Supreme Court held in a 5-2 decision that the two-thirds threshold applied only to ballot measures initiated by local governments. Because they were not local government measures, those qualified by citizen initiatives only needed simple majority support to be enacted.

In dissent, Justice Kruger took square aim at the idea that this interpretation was what voters expected in 1996 when they made it harder for local governments to raise taxes.

Kruger wrote, “A tax passed by voter initiative, no less than a tax passed by vote of the city council, is a tax of the local government, to be collected by the local government, to raise revenue for the local government. None of this could have been lost on the electorate that, also by initiative, amended the California Constitution to set ground rules for voter approval of local taxes.”

A key moment, buried amid nearly 13 hours of recorded meetings, came when CalPERS’ Chief Investment Officer Ted Eliopoulos played a short interview video with Wall Street experts, including famed investor Warren Buffett, opining on the expected investment returns in coming years. One investment guru thought a 4 percent or 5 percent rate of return would be the objective. Buffett pointed to very slow growth in the economy.

Eliopoulos used a diagram showing a 30-year decline in interest rates, even as discount rates used by pension funds remained steady. CalPERS currently calculates its pension liabilities based on an expected return rate of 7.5 percent. Based on the data provided by CalPERS staff, it’s clear the agency would need to ramp up its risk taking to have any chance to continually meet such goals. In the past year, CalPERS’ return rate was 0.6 percent.

Longtime pension-reform advocate Daniel Pellissier, president of California Pension Reform in Sacramento, praised the CalPERS staff for its bout of truth telling, given that such predictions are not what the current system’s defenders want to hear. “I’d like to think they actually have a conscience and they understand the role they play,” he said. “What do you do when you’re facing flat returns for years ahead and liabilities are rising?”

The staff is “pushing the board to do the right thing,” Pellissier added. “Some board members are essentially saying to staff: Make me do the right thing.” The “right thing,” in Pellissier’s view, is to further reduce the expected return rates to more closely match market performance. He compares the situation to 1999, when CalPERS officials did not sound the alarm bells about the looming costs that would follow SB400, the law that led to 15 years of statewide retroactive pension increases and that still plagues the system to this day.

At least one CalPERS board member complained about the cost of reducing the discount rate. There’s no doubt that doing so means that California cities will face costly spikes in their payments. But in reality, the costs are already there. State and local governments have already made pension promises to public employees. The courts have consistently enforced the so-called “California Rule,” which stops agencies from lowering benefits for current employees, even going forward.

The question, according to reformers like Pellissier, is how forthright state officials will be in accounting for the size of the pension-related debt. Few dispute the essential point: Governments have undercharged municipalities for the cost of pension benefits, possibly for decades. They have to keep those promises. The “unfunded pension liability” is essentially the debt – the difference between what’s promised and the available funds.

In the private sector, employees typically receive defined-contribution plans, generally 401(k)-style benefits. The employee contributes a certain percentage into a fund. Sometimes the employer matches a portion of the contribution. The money is invested in mutual funds. When the market does well, the employee reaps the benefits. When it does poorly, the employee endures the downside. The employee uses whatever is in the fund for retirement. There are no “liabilities.”

The government pension plans that CalPERS manages are an entirely different animal. Agencies make benefit promises to employees based on a formula. For instance, most public-safety officials (police, fire, prison guards) in California receive “3 percent at 50.” That means they retire with 3 percent of their final years’ pay times the number of years worked, available at age 50 – plus myriad pension “enhancements” added at the end of the career. That level — 90 percent or more of final pay — is guaranteed, no matter what.

This explains the heated debate over investment-return predictions. If the market does well, there are fewer forecast debts. If it does poorly, those liabilities soar. Because taxpayers are pledged to backfill any shortfalls, it’s a highly political issue. Additionally, critics note that the CalPERS board is dominated by union officials whose members benefit from painting as rosy a scenario as possible about the future investment performance.

Union officials argue the system is fine and that, despite recent poor performance, CalPERS does well over time. Returns have been terrible since 2014, but outperformed predictions between 2009 and 2013. But even the CalPERS staff’s presentation suggests it’s unrealistic to bank on continuing 7.5 percent return rates in the current market.

As Pensions & Investments reported, “Andrew Junkin, president of Wilshire Consulting, the pension fund’s general investment consultant, told the committee its firm estimates the pension fund’s annualized investment return over the next decade will be 6.2 percent, down 90 basis points from the 10-year forecast Wilshire made a year ago of 7.1 percent.” The publication noted that CalPERS could vote on a rate reduction in February.

Pension-reform advocates aren’t the only ones raising the ghost of SB400 in the current context. “It’s time to put SB400, the 1999 California legislation that changed benefits for public workers, behind us,” argued CalPERS board members Richard Costigan, Dana Hollinger and Bill Slaton in a September column. “That bill … was a product of its time. Retirement security is too important today to get caught in a debate about the past. When SB400 became law, CalPERS was 137 percent funded.”

They vowed to examine the situation in light of the current, tougher economic climate. The staff presentation at the recent Board of Administration meetings suggest those words were more than public relations. Top CalPERS officials seem to recognize the size of the looming problem. The real test will come in December committee meetings and at the next board confab. But it’s increasingly likely that return predictions are headed downward.

Steven Greenhut is Western region director for the R Street Institute. Write to him at sgreenhut@street.org.