California agencies are trying to figure out the implications of a vague executive order issued by Gov. Gavin Newsom in September that orders many policy decisions to be made with the need to “mitigate climate change” kept in mind.

A recent Sacramento Bee story suggested that among the most vexed were the California Public Employees’ Retirement System and the California State Teachers’ Retirement System, the two pension giants with estimated unfunded liabilities of $136 billion and $107 billion, respectively, according to 2018 data.

The Bee reported that while the Newsom administration wasn’t ordering CalPERS and CalSTRS to divest from firms involved in fossil fuel, it was requiring them to make new investment decisions that reflect “the increased risks to the economy and physical environment due to climate change.”

Newsom thinks fossil fuel companies are in trouble

This reflects the assumption of the Newsom administration that there will be a rapid shift away from fossil fuels – a view that many hedge funds, mutual funds and large institutional investors don’t share. Large energy corporations remain popular with their stock pickers despite global warming fears. And contrary to the idea that these companies are in decline, some investors see fracking continuing to increase oil production in the U.S. for years to come. Last week, for example, the Motley Fool investment website strongly recommended buying ExxonMobil in 2020, noting that its annual divided “has increased more than 100 percent over the past 10 years.”

Newsom’s edict is producing heartburn with some members of the CalPERS board. That’s because, as the Bee noted, “pension systems have a financial obligation to earn as much as cash as possible to provide retirement security for millions of government employees.”

Former Garden Grove Unified manager Margaret Brown, a CalSTRS critic who won election to the board in December 2017, wrote on Twitter that “unless the governor is willing to take even more $$$ from over-taxed California citizens, Newsom should step back.” 

Corona police Sgt. Jason Perez upset CalPERS Board President Priva Mathur in the October 2018 election after running a campaign that blasted Mathur and other trustees for not focusing solely on returns in their investment decisions.

But the CalPERS and CalSTRS boards have a history of using investments for decades to make political statements. In September, state Treasurer Fiona Ma – who sits on both boards – strongly endorsed such investment activism.

CalPERS quietly shifting from low-risk ‘passive investing’

That means CalPERS and CalSTRS executives are under heavy pressure to improve returns while making investments that can be defended as socially responsible.

The Naked Capitalism website reported in October that this pressure may have led to CalPERS making a major shift in investing part of its portfolio. Instead of traditional “passive equity investing” in index funds that track the S&P 500 or other large categories of stocks and emphasize diversified portfolios, CalPERS has begun to adopt a more aggressive “factor investing” approach that has a chance of generating bigger returns by focusing on industries with better prospects for short- and medium-term gains, among its many tenets. The approach is also somewhat riskier than using index funds.

Reporter Yves Smith wrote that this was a major shift in investment strategy on a par with “CalPERS’ renouncement of hedge funds” in 2014.

The website, which is run by veterans of the global financial industry, has broken a series of stories about CalPERS in recent years.

In August 2018, it revealed that CalPERS CEO Marcia Frost had misrepresented her academic background and didn’t have a college degree.

This August, it offered evidence that CalPERS was hiding a negative audit of its hiring practices that had been triggered in part by the agency’s failure to vet Frost’s claims.

A new Public Policy Institute of California poll shows the number of state residents worried about the cost of government pensions is at a 14-year low. In recent remarks to the Commonwealth Club in San Francisco, new state Superintendent of Public Instruction Tony Thurmond rejected the idea that pension costs were generally a major problem for school districts around the state.

But a recent comprehensive review by the Bond Buyer painted a starkly different picture. Based on interviews with officials in credit-rating agencies and the state’s Fiscal Crisis Management Action Team (FCMAT), as well as reviews of financial records from large school districts across the state, it forecast a wave of state takeovers of districts under the provisions of a 1991 state law that provides emergency loans to districts that can’t pay bills. But the loans come with the condition that district superintendents and school boards lose considerable autonomy over their budgets, which must have as a first priority repaying the loan to the state.

Nine districts have taken out such loans since 1991, and the Sacramento City Unified School District could become the 10th this fall when it is expected to run out of dwindling cash reserves.

A Fitch Ratings analysts told the Bond Buyer that about 50 of the 124 school districts it tracks have such low reserves that if an economic slowdown froze or reduced state revenue, those districts could quickly lose their capacity to pay bills. The same problems seen by Fitch in the larger districts that it monitors are likely to be seen in the 1,000-plus smaller districts it doesn’t track.

Low birth rate hurts enrollment

Since California’s overall population keeps going up, that’s obscured a key complication in school finances: The fact that school enrollment in much of the state is in the middle of a broad, long-term decline driven by changing demographics and birthrates that in 2017 hit an all-time low for the Golden State. FCMAT CEO Michael Fine estimates that 65 percent of the state’s 1,200 districts have fewer students than they used to. Perhaps the most dramatic decline is in Inglewood Unified, where present enrollment is 8,000 – about 40 percent of what it was in 2004.

Because state funding is based on the Average Daily Attendance formula, the enrollment declines can hammer districts even in a decade in which state funding for education has increased by more than 70 percent. That’s because many school districts don’t reduce their staffs by an amount equal to the lost enrollment. A FCMAT report on Oakland Unified issued last May called this a key factor in the financial strain faced by the district.

Another issue is that retirement benefits in some districts don’t just include pensions from the California State Teachers’ Retirement System. Some districts, including Los Angeles Unified and Sacramento City, offer generous health insurance to retirees for as long as they live.

S&P rating service downgraded LAUSD’s bonds last month. Fitch downgraded some of Sacramento City’s bonds in February, and further downgrades seem certain.

CalSTRS needs booming market

Officials with CalSTRS remain optimistic that healthy investment returns can reduce CalSTRS’ present unfunded liabilities of about $100 billion. Boom markets on Wall Street have at times allowed CalSTRS to keep mandatory pension contributions relatively flat for years at a time.

But the 2007 recession hammered CalSTRS, forcing the Legislature and Gov. Jerry Brown to pass a bailout measure in 2014 that will roughly double annual contributions from districts, the state and teachers by July 2020, when its final increase is phased in.

But hopes that profitable investments will be a big help in reducing liabilities aren’t coming to pass. The Sacramento Bee reported recently that CalSTRS only had a 1.62 percent return on its portfolio for the first eight months of fiscal 2018-19 and was not expected to meet its target of a 7 percent annual return.

Next fiscal year, Newsom wants to give $3 billion to the California Public Employees’ Retirement System. He also proposes giving up to $5.9 billion over four years to the California State Teachers’ Retirement System.

Both funds have less than 70 percent of the assets they will need to pay off promised pensions. Last year, CalSTRS’ unfunded liability was estimated to be $107.3 billion and CalPERS’ was put at $136 billion. Some see Newsom’s proposal as a confirmation of the failure of ballyhooed efforts by Gov. Jerry Brown and the Legislature to reform pensions and shore up the pension giants.

In 2012, they enacted the California Public Employees’ Pension Reform Act (PEPRA). It changed retirement terms for state employees hired after Jan. 1, 2013, by limiting what types of pay would apply toward pensions and by making small reductions to benefit calculation formulas and pushing back when employees could retire.

Brown hailed the law’s passage as a significant first step toward Sacramento bringing pension costs under control.

The next significant step came in 2014, when the Legislature and Brown approved a bailout of CalSTRS. It gradually raised the $5.7 billion that school districts, the state and teachers contributed to CalSTRS in 2013-14 to $11 billion in 2020-21, when the phased-in increases were complete. Districts have to pay for 70 percent of the new contributions, with the state picking up 20 percent and teachers 10 percent.

‘Significant’ CalSTRS changes didn’t stabilize fund

The nonpartisan state Legislative Analyst’s Office described the funding law as a “significant” accomplishment with promise to keep CalSTRS on firm ground for decades to come.

But as Brown’s second term wore on, with CalPERS alternating between poor and relatively successful years with its investments, it became clear that the 2012 pension reform measure hadn’t changed the grim long-term picture for CalPERS’ finances. A 2017 Pensions & Investment report detailed how CalPERS’ 10-year record of 4.4 percent average returns wasn’t keeping up with its obligations and noted that in one poor investment year alone, CalPERS saw its unfunded liabilities soar by $27.3 billion.

And the LAO soon changed its tone on the CalSTRS bailout. In 2016, its analysts warned that liabilities continued to increase. And in November, as CalWatchdog reported, an internal CalSTRS analysis concluded there was a 50 percent chance that CalSTRS’ funding would drop to less than 50 percent over the next 30 years. Pension analysts note that few pension systems ever recover from dropping below the 50 percent level.

Perhaps the most significant hope for pension reform from the Brown era came as the surprise result of a legal challenge to some of the limits on pensions for new hires in the 2012 law. A public safety union argued that this was a violation of the “California rule,” the long-standing court precedent that held pension benefits could not be reduced for public employees without comparable additional benefits being provided.

But two appellate courts not only disagreed with the lawsuit’s premise, they held the “California rule” of inviolate pensions didn’t apply to years not yet worked by public employees, and that cheaper benefits could be collectively bargained.

The California Supreme Court held a hearing on the lawsuit last month and a decision is expected in coming weeks.

The California Public Employees Retirement System and the California State Teachers Retirement System recently announced that they had exceeded their investment goals by at least 1 percentage point in fiscal 2017-18, with CalPERS citing annual gains of 8.6 percent and CalSTRS reporting 9 percent returns.

This came after strong returns in 2016-17 as well for both of the pension giants. But even with CalPERS now reporting $355 billion in assets and CalSTRS $225 billion, both systems have 70 percent or less of funds needed to cover their long-term commitments.

This troubling long-term picture is why the League of California Cities, in a January report, said it expects CalPERS to keep raising rates on local governments for years to come until they become “unsustainable.” CalSTRS, meanwhile, relies on the Legislature to set the rates it charges workers, districts and the state for pension costs – and the bailout the Legislature approved in 2014 that sharply increased what districts in particular must pay has not shored up the system nearly as much as was hoped.

Against this backdrop, CalPERS and CalSTRS are offering hints that they aren’t happy with the Legislature and think it is making their jobs more difficult.

CalSTRS’ chief investment officer, Christopher Ailman, issued a statement about the good returns that downplayed their significance: “We will rank high compared to similar funds, but it is only one year. We need to repeat that performance year in and year out, on average, over the next 30 years.”

But in an interview with the Private Equity International website that was posted July 2, Ailman elaborated on his view of investment gains. He did so in a way that challenged claims made by many Democratic lawmakers and pro-pension groups such as the Californians for Retirement Security that state pensions’ biggest problem was the Wall Street crash of a decade ago.

CalSTRS exec: Don’t blame investment results

“Ailman points out it’s often not the investment results that have led to the underfunding, it’s either poor management of liabilities or a lack of contributions,” the article said.

“Asked whether this keeps him up at night, he says he sleeps like a baby – wakes up and screams every three hours. ‘We pay out half a billion dollars a month in benefit payments, more than we bring in.’”

In the interview, Ailman also complained about Assembly Bill 2833, a state law that took effect last year that requires pension systems to disclose more information about expenses and fees related to their investments. He said the law ignored existing disclosure requirements and that it had caused CalSTRS to miss out on lucrative opportunities.

He said the “extra rules and extra issues” were having unintended but negative effects.

“We now have a situation in the state of California where CalPERS and CalSTRS have less invested in Silicon Valley than the Dutch, Asian and Middle Eastern sovereign wealth funds. Fundamentally, as a native Californian I think that’s just so wrong, but I can’t change people’s minds. It is what it is now,” Ailman told Private Equity International.

CalPERS knocks bill to monitor divestment laws

CalPERS’ concerns about legislative actions are also plain, if more muted. The Pensions & Investments website reported July 18 that the pension fund opposes Senate Bill 783, which already passed the Senate and now is before the Assembly. It would set up a review body to analyze how CalPERS and CalSTRS had complied with state laws directing the pension funds to divest from certain industries. CalPERS says this review panel would duplicate the work of pension staffers.

Given that CalPERS and CalSTRS at times have resisted the Legislature’s attempts to micromanage their portfolios, SB783 could be seen as giving teeth to lawmakers’ attempts to have a bigger say in investments.

The debate over SB783 comes as CalSTRS faces demands from activists to divest in a new corner of the private sector: companies which run private prisons. Other recent calls for divestment have targeted assault-rifle makers; finance companies that helped with construction of the Dakota Access Pipeline; and fossil-fuel companies.

New York Gov. Andrew Cuomo’s call for his state’s biggest government pension fund to

The Common Fund – New York’s pension fund for state and local public sector employees – has $200 billion in holdings. Cuomo, a Democrat who is expected to run for president in 2020, said it was time to craft a “de-carbonization roadmap” for the fund, which “remains heavily invested in the energy economy of the past.”

New York City Comptroller Scott Stinger agreed with Cuomo and called for changes in the investment policies of the city’s five pension funds, with holdings of about $190 billion.

The announcements were hailed on social media as a reflection of the mission statement of the 2015 Paris Accord outlining international efforts to address global warming.

It’s possible Brown could use his State of the State speech later this month to reveal his call for CalPERS and CalSTRS climate-change divestment. The pension giants have already been forced to end investments in coal companies because of a 2015 law signed by the governor, selling off shares worth less than $250 million, a tiny fraction of their overall portfolios.

But selling off stakes in energy companies would be a much more impactful event. Giant firms like ExxonMobil are among the most common holdings of pension funds around the world.

Some unions worry divestment will hurt CalPERS finances

And while the California Democratic Party has been largely unified behind Brown’s and the state Legislature’s efforts dating back to 2006 to have California lead the fight against global warming, such unanimity is unlikely should Brown follow Cuomo’s lead because some public employee unions are worried about divestment damaging the finances of CalPERS and CalSTRS.

As of July, CalPERS had $323 billion in assets and said it was 68 percent funded – meaning it had about $150 billion in unfunded liabilities. As of March, CalSTRS had $202 billion in assets and said it was 64 percent funded, leaving unfunded liabilities of about $100 billion.

CalPERS’ steady increase in rates it charges local agencies to provide pensions and the heavy costs facing school districts because of the Legislature’s 2014 CalSTRS’ bailout have taken a heavy toll on government budgets.

Corona Police Lt. Jim Auck, treasurer of the Corona Police Officers Association, has testified to the CalPERS board on several occasions, imploring members to focus on making money with investments, not making political statements.

According to a July account in the Sacramento Bee, Auck said public safety is hurt when police departments must spend ever-more money on pensions.

“The CalPERS board has a fiduciary responsibility to the membership to deliver the best returns possible,” Auck testified. “Whatever is delivering the return they need, that’s where they need to put our money.”

The International Union of Operating Engineers, which represents 12,000 state maintenance workers, has taken the same position, according to the Bee.

In New York, Gov. Cuomo also is not assured of success. The sole trustee of the Common Fund is State Comptroller Thomas P. DiNapoli. While he agreed to work with Cuomo in establishing a committee to consider possible changes in its investment strategies, his statement pointedly emphasized that there were no present plans to change the fund’s approach to energy stocks.

While DiNapoli cited his support for reducing global warming and the Paris Accord, his statement concluded with a sentence emphasizing his priorities: “I will continue to manage the pension fund in the long-term best interests of our members, retirees and the state’s taxpayers.”

This often comes in the form of divestment, by which the funds are encouraged – or even required – to sell their assets in industries that are viewed negatively by the people who push these efforts. These efforts tend to work against the goals of the funds’ professional investment staff, which are charged with getting high investment returns to fund pensions for the systems’ retirees. Both funds have a fiduciary responsibility to maximize their return on taxpayer dollars.

Yet estimates from a consulting firm suggest that CalPERS has lost approximately $8 billion in returns because of previous efforts to divest from coal-related and tobacco industries. That’s become a particularly contentious issue as funding levels have fallen to 68 percent for CalPERS and 64 percent for CalSTRS. That means they have only around two-thirds of the assets needed to make good on all the current and future pension promises made to government retirees.

Despite the troubling numbers, there’s a new push for divestment from some politicians. Following the October massacre in Las Vegas, by which a gunman murdered 59 people at a country music concert, state Treasurer John Chiang has called for the teachers’ fund to sell its assets in weapons firms and sporting-goods companies that sell any guns that are illegal in California.

“Neither taxpayer funds nor the pension contributions of any of the teachers we represent, including the three California teachers slain in Las Vegas should be invested in the purveyors of military-style assault weapons,” said Chiang, a 2018 candidate for governor and member of both pension boards. Chiang also told the Sacramento Bee that he plans on making a similar request to the CalPERS board.

The newspaper also noted that both funds “this year have faced calls to divest from companies that do business with the controversial Dakota Access Pipeline,” which would transport oil underground from North Dakota oilfields to Illinois. It has prompted protests from a variety of environmental and Native American activists.

Critics of these proposals say they are largely symbolic and would do little to influence gun sales or the pipelines. Divestment from these relatively small industries wouldn’t have much impact on the massive funds’ financial returns, either.

On Oct. 30, 12 members of California’s Democratic congressional delegation sent a letter to CalPERS chief executive officer Marcie Frost urging the pension fund to divest from a fund that has acquired a hotel owned by Donald Trump’s organization. This move is more directly political than many divestment efforts, which tend to focus on the social implications of investing in the pipeline, weapons manufacturers, coal-related industries and tobacco companies.

Divestment advocates sometimes argue that these controversial products may be poor long-term investments. For instance, the Public Divestiture of Thermal Coal Companies Act of 2015 and similar efforts by the state insurance commissioner were based in part on the notion that these coal-related companies may face diminishing values as the world shifts away from carbon-based fuels – a point rebutted by those who note that the current price of the stocks already reflects that risk.

But the Trump-related divestment call, led by U.S. Rep. Ted Lieu of Torrance, is designed to target the president. The members of Congress expressed their disappointment that CalPERS “has not divested its interest” in that fund “nor has taken any actions to ensure that its fees are not being transferred to President Trump,” according to their letter. They criticized CalPERS for taking a “wait-and-see” approach toward the matter.

These members of Congress claim that this CalPERS investment could be in violation of the Domestic Emoluments Clause of the U.S. Constitution, which states that “no Person holding any Office of Profit or Trust under them, shall, without the Consent of the Congress, accept of any present, Emolument, Office, or Title, of any kind whatever, from any King, Prince, or foreign State.” This would be an unusual interpretation of an arcane clause.

Meanwhile, the pension funds have been expanding other divestment and socially motivated investment efforts. Last December, the CalPERS investment staff “recommended that the board remove its 16-year ban on tobacco investments in light of an increasing demand to improve investment returns and pay benefits,” according to a Reuters report. But instead of removing the ban, the board “voted to remain divested and to expand the ban to externally managed portfolios and affiliated funds.”

And last year CalPERS adopted a five year Environmental, Social and Governance plan that focuses on socially responsible investing. The fund has long used its financial clout to push companies it invests in to promote, for instance, board diversity and other social goals.

Whatever their chances for approval, the latest efforts are not out of the ordinary. But they will rekindle the long-running debate between political and financial goals, and whether the former imperils the latter given both funds’ large unfunded liabilities.

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

California’s funding of education has gone from $50.4 billion in the fiscal year that ended in 2012 to $74.5 billion for the current fiscal year – a

Nevertheless, this summer has seen a steady stream of stories from school districts up and down the state warning of tight budgets, coming layoffs and worse. Ron Bennett, CEO of School Services of California, which advises more than 85 percent of the state’s nearly 1,000 districts, told the Bay Area News Group that one-third of districts face deficit spending in the 2018-19 school year and two-thirds do in 2019-20.

The common problem facing all districts is the phased-in cost of the 2014 bailout of the California State Teachers’ Retirement System. Gov. Jerry Brown and state lawmakers agreed to a plan in which school districts would increase their contributions by 132 percent from 2014-15 to 2020-21 – picking up 70 percent of the cost of the bailout, with the state general fund and teachers covering the rest. This is accomplished by gradually raising district’s pension contributions from 8.25 percent of teacher pay to 19.1 percent of pay, which sharply increases compensation costs that already go up annually no matter what because California teachers typically get “step” raises of 3.5 percent to 4 percent in 15 of their first 20 years in the classroom.

The next most common problem is declining enrollment. ADA – average daily attendance – is the fundamental formula determining how much money the state gives each school district. While California’s population continues to inch up, in December, its birth rate fell to a historic low. Urban, suburban and rural districts have all been buffeted as a result.

Teacher pay raises add to fiscal stress

Exacerbating these two structural problems is the fact that after the state’s 2008-2012 revenue recession ended, politically powerful local teachers unions won substantial pay raises in many districts.

The most telling example: In the state’s largest district, Los Angeles Unified, United Teachers Los Angeles was given a 10 percent pay raise in 2015.

This has added to budget and management problems that have led one prominent educator, former Long Beach Unified and San Diego Unified Superintendent Carl Cohn, to call for LAUSD to be broken up.

District officials tried to put up a happy front after its 2017-18 budget was adopted last month. But a Los Angeles Times review of long-term spending plans suggested district officials were not taking serious steps to deal with a 2019-20 deficit expected to be more than $400 million. It noted that while L.A. Unified’s enrollment, now 514,000, continues to drop, the district has more administrators than ever.

Similar problems are seen throughout the Golden State.

Once adjusted for district size, Rim of the World Unified in the Lake Arrowhead area of San Bernardino County is in among the worst binds of any district in the medium term. The 2017-18 budget is not expected to run a deficit, but huge cuts are certain in 2018-19, when the six-school district has to deal with a projected $2.1 million deficit, and schools may have to close or consolidate in 2019-20, when a $4.5 million shortfall has been forecast.

In the affluent Silicon Valley, districts are also being pinched. The San Jose Unified School District needs to cut 150 jobs before its 41 schools reopen next month. Cupertino Union School District and its 25 schools, which made $2.6 million in cuts this spring, are sure to need another round of layoffs by next spring, when a $5.6 million deficit is expected.

The Napa Valley Unified School District, facing a $12.4 million shortfall in a $167 million 2017-18 budget, laid off 50 teachers who hadn’t gained tenure yet and eliminated 60 classified positions. Trustees are already warning of even worse cuts in coming years.

Such budget bloodbaths are the norm across California.

One of the relatively few bits of good news on the school finance front comes – unexpectedly – from Washington. After Donald Trump won the White House, some Democrats expected Trump and the Republican-controlled Congress to seek huge cuts in federal education aid to states – especially liberal ones like California.

But EdSource reported in May that the Trump administration’s budget plan would reduce annual federal education funding for the state from about $4 billion to $3.64 billion – a cut of less than 10 percent. The proposed cuts would be proportional – meaning Trump didn’t single out states he lost for less generous treatment.

In a shock critics had warned against, Golden State schools discovered that their nation’s largest pension system, CalPERS, was on track to force substantial budgetary cutbacks on core education spending. 

“Public schools around California are bracing for a crisis driven by skyrocketing worker pension costs that are expected to force districts to divert billions of dollars from classrooms into retirement accounts, education officials said,” the San Francisco Chronicle reported. “The depth of the funding gap became clear to district leaders when they returned from the holiday break: What they contribute to the California Public Employees’ Retirement System, known as CalPERS, will likely double within six years, according to state estimates.”

Bad grades

The controversy hit as a fresh study brought unwelcome news about California’s nationwide education standing. The report, by Education Week, “looked at multiple ways that states are educating and preparing children for school,” the San Jose Mercury News reported. “For pupil achievement, for instance, the magazine considered 18 measures such as graduation rates, reading and math tests, Advanced Placement exam results, equity and achievement gaps.”

“In academic performance — as measured by the 2015 National Assessment of Educational Progress test and by poverty figures — California earned a D-plus. But in improvement over time, the state posted a C. In equity, California scored a relatively high B-minus — but that was still 41st in the nation, and below the national average of a B.”

A spokesman for California Superintendent of Public Instruction Tom Torlakson called the data behind the survey “outdated,” the Mercury News added, although it was no older in California’s case than any other state. “California is moving in a positive direction,” the spokesman insisted. “We’ve dramatically increased our investment in education.”

Underperformance

But that investment, according to new estimates, has been placed at risk of being consumed by pension costs. “There is a predicted shortfall among all state retirement accounts of at least $230 billion based on what’s owed to current and future retirees. The pension funds, including CalPERS, haven’t made as much money from the stock market and other investments as they had hoped,” the Chronicle noted. “CalPERS officials had hoped to gain a 7.5 percent annual return on investments, but they didn’t come close in either of the last two years.”

Despite optimistic predictions, underperformance has been a constant for the fund: “Over the last 20 years investment returns averaged only 6.9 percent, with the current annual return bringing in only 2.3 percent,” Pepperdine professor Joel Fox observed in the Orange County Register. “Facing market realities, the board lowered the estimate to 7 percent, a mark that still may be unattainable.”

“For taxpayers, the number change likely means more dollars from state and local government budgets will be directed to cover pension liabilities and less will be available to meet services supplied by government. The city of Los Angeles already dedicates 20 percent of its budget for pension obligations, Anaheim 13 percent, Long Beach 11 percent and San Jose as high as 27 percent.”

Double burden

At the same time, school districts have howled over the additional adverse impact of the state’s other pension liabilities. “In 2014, the Legislature adopted Assembly Bill 1469, which seeks to pay down CalSTRS underfunding over about 30 years by relatively small increases in contributions from teachers and the state, and by increasing school districts’ contributions over seven years by 10.85 percent,” former Piedmont USD Board of Education member Richard Raushenbush wrote in the East Bay Times. “In 2020, school districts’ CalSTRS contributions will be 19.1 percent of teacher payroll!”

“This is not sustainable. School districts are funded by the public to provide free public education; they do not make profits that can be devoted to paying off the Legislature’s CalSTRS debt. The Legislature did not provide any new funds to pay the significant CalSTRS’ increases.”

The California Public Employees’ Retirement System has not had a good 2016. Its investment returns were

But year’s end brought good news of a morbid nature to CalPERS, the California State Teachers’ Retirement System and all agencies with actuarial responsibilities: It appears that U.S. life expectancy has plateaued after the nation previously seemed on track to eventually join Iceland and Japan as nations where it was common for people to reach their 90s.

This upward trend was blamed in San Francisco for the failure of pension reforms enacted in 2011 to provide much relief, as CalPERS reported last year, and has been one more factor in making long-term pension reform such a daunting test.

But after more than two decades of incremental but cumulatively significant increases in life expectancy, life expectancy went down slightly in 2015, according to the National Center for Health Statistics. There were increases in eight of the 10 leading causes of death, including heart disease, diabetics, drug overdoses, Alzheirmer’s, diabetes and suicide. Cancer was the only notable bright spot, with deaths down 1.7 percent.

U.S. life expectancy rose from 75.4 in 1993 to 78.9 in 2014 before dropping to 78.8 in 2015, according to the latest report.

The findings were in line with a report last year from Princeton economists that showed an increase in death rates among middle-aged whites, a development that was linked to the opioid epidemic and other self-destructive behavior.

CalPERS knocked for slowness in adjusting actuarial formulas

While social scientists and elected leaders ponder the implication of this development for the nation, it could provide a sense of relief at CalPERS. The pension fund has faced sharp criticism of “cooking the books” not just by having unrealistic expectations of earnings but by being slow to acknowledge its pensioners were living longer.

In early 2014, the Bay Area News Group’s Dan Borenstein wrote a column about CalPERS’ actuaries’ struggle to get the CalPERS board to adjust life expectancy forecasts. The actuaries got their way after grousing from some board members that this would increase costs for member agencies.

But Chief Actuary Alan Milligan remained worried that not enough was being done. In January 2015, CalPERS posted a mortality report that noted mortality had improved “a bit faster” than pension fund actuaries expected. It noted that CalPERS was now “predicting faster improvements than we had in the past.”

The prediction might still prove right. While most public-health experts agreed that the National Center for Health Statistics report was bad news, there were some who warned against an overreaction to the findings.

Slate published an analysis by Ben Hanowell, a data scientist who works for a company that connects the aging with assisted living. He warned against positing broad trends from one year of data and noted that some groups — such as middle-aged Hispanics and African Americans — continued to see their life expectancy increase.

As of June 30, CalPERS had 68 percent of funds for its anticipated obligations to public employee retirees — $139 billion less than needed.

In August, a California appeals court ruled against the Marin County Employees’ Association in its case challenging a 2012 state law reining in pension-spiking abuses – i.e., those various end-of-career enhancements (unused leave, bonuses, etc.) that public employees use to gin up their final salary and their lifetime retirement pay.

One of the few areas of widespread agreement at the Capitol on public-employee pensions involves spiking. Gov. Jerry Brown signed into law the Public Employees’ Pension Reform Act of 2013, known as PEPRA, to reduce escalating pension liabilities. Most of its provisions applied to new hires only. The governor also signed related legislation, Assembly Bill 187. Its goal was to “exclude from the definition of compensation earnable any compensation determined … to have been paid to enhance a member’s retirement benefit.”

This limitation on pension spiking was implemented by the Marin County Employees’ Retirement Association to help the county reduce its pension debt. As the court explained, “Reaction to the change in policy was almost immediate.” Five public-employee associations filed suit, claiming that a ban on these spiking conditions reduced promised levels of pay to their members. They argued this was an impairment of their “vested rights.” Vesting confers ownership rights.

Even though the dollars at issue are relatively minimal, the case has become a major flashpoint. California courts have long abided by something known as the “California Rule.” It’s not a law or even a rule, actually. It refers to a series of court rulings concluding that once a pension benefit is granted to public employees by a legislative body (board of supervisors, city council, state legislature), it can never be reduced – even going forward.

In the private sector, for instance, courts allow employers to reduce pension benefits, starting tomorrow. Employees could be paid everything promised to the point of the benefit change, but they can have certain benefits removed or reduced in the future. That’s seen as reasonable given they haven’t earned them yet. It’s different in the public sector.

In California (and a number of other states that follow a similar rule), these benefits can never be reduced. The problem, from a public-finance point of view, is that reducing benefits for new hires only won’t address the bulk of the debt problem until those employees start retiring in 25 or 30 years. Fixing the current debt problem requires dealing with current employees.

Ironically, almost all of the benefit increases public agencies have granted to union members since the 1999 passage of Senate Bill 400 have been done “retroactively.” In other words, the courts have allowed public agencies to give a boost in pensions to public employees for years they previously have worked – but they won’t allow those same agencies to reduce future benefits for years that have yet to be worked. This is politically controversial, but there’s little debate that such a rule has been followed by the courts.

“Public employees earn a vested right to their pension benefits immediately upon acceptance of employment and … such benefits cannot be reduced without a comparable advantage being provided,” according to the plaintiffs, as quoted in the appeals court decision. “A corollary of this approach is that public employees are also entitled to any increase in benefits conferred during their employment, beyond the benefit in place when they began.” In this view, compensation is a one-way ratchet.

This understanding has largely undermined every major reform proposed in California. For instance, the courts gutted the city of San Jose’s voter-approved 2012 pension-reform initiative because it rolled back future benefits for current employees. And the “California Rule” has been the obstacle that has stopped reformers from coming up with other similar approaches.

In this case, Justice James Richman ruled, “(W)hile a public employee does have a ‘vested right’ to a pension, that right is only to a ‘reasonable’ pension – not an immutable entitlement to the most optimal formula of calculating that pension. And the Legislature may, prior to the employee’s retirement, alter the formula, thereby reducing the anticipated pension. So long as the Legislature’s modifications do not deprive the employee of a ‘reasonable’ pension, there is no constitutional violation. Here, the Legislature did not forbid the employer from providing the specified items to an employee as compensation, only the purely prospective inclusion of those items in the computation of the employee’s pension.”

The judge pointed to conclusions from California’s watchdog agency, the Little Hoover Commission, pointing to uncontrollable unfunded pension liabilities. As the commission explained, “To provide immediate savings of the scope needed, state and local governments must have the flexibility to alter future, unaccrued retirement benefits for current workers.” The commission pointed to spiking as a particular problem. This report, he wrote, is part of what motivated the state Legislature and governor to implement reform.

Furthermore, the judge pointed to previous cases acknowledging that government entities have the right to “make reasonable modifications and changes in the pensions system ‘to permit adjustments in accord with changing conditions and at the same time maintain the integrity of the system and carry out its beneficent policy.’” This echoes what myriad pension reformers have argued: agencies are not stuck watching their systems go over the cliff. They have the right and duty to make adjustments to assure their future solvency.

If the California Supreme Court sides with the unions, then local governments will have fewer options left to gain control of their pension debts. If the court agrees with Judge Richman, then pension reform could be a brand new ballgame – although it’s unclear whether the court might toss the California Rule entirely or simply allow localities to change some of the benefits within the framework of that rule.

The court has 60 days to decide whether to consider the matter, according to reports. Unions and reformers will no doubt be watching the court’s decision closely.

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