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 governor’s plan is similar to the idea of pension-obligation bonds. That’s when a government borrows money to pay down escalating pension debts, in the hopes “that the bond proceeds, when invested with pension assets in higher-yielding asset classes, will be able to achieve a rate of return that is greater than the interest rate owed over the term of the bonds,” according to an explanation from the Government Finance Officers Association.

The governor’s plan, by contrast, would borrow money from the Surplus Money Investment Fund, a low-interest (around 1 percent) account where the state holds money to pay for short-term expenses. It would then make a supplemental $6 billion payment to the California Public Employees’ Retirement System (CalPERS), which currently predicts a rate of return of 7 percent (even though last fiscal year it received only 0.61 percent). If the CalPERS fund performs as predicted, it will allow the state to save $11 billion in pension liabilities over two decades.

“Absent additional action to address these growing liabilities, paying off retirement liabilities will require an increasing percentage of the state budget. For example, the state’s contributions to CalPERS are on track to nearly double from $5.8 billion ($3.4 billion General Fund) in 2017‑18 to $9.2 billion ($5.3 billion General Fund) in 2023‑24,” according to the May budget revision’s summary. This is purportedly a painless way to pay down growing pension debts.

The idea got a boost from one of California’s best-known pension reformers, Sen. John Moorlach, an Orange County Republican who recently introduced a package of pension reform bills in the Senate. They were all killed by majority Democrats. Nevertheless, Moorlach wrote, in a column for Fox & Hounds that he wishes the governor’s prepayment plan had “a little more sizzle to make it an even more interesting opportunity.”

“Governor Brown should ask the board of CalPERS what type of incentive they will give the state for the prepayment,” he wrote. “CalPERS will benefit from the large influx and should provide at least a 3.75 percent reduction on the actuarially calculated required contribution.” That’s unlikely to happen, of course, but Moorlach wrote that he likes the Brown proposal and thinks the governor should move forward with it.

The idea follows the lead of the Orange County city of Newport Beach, explained Ed Mendel, in his May 29 Calpensions article. The city is paying down its pension debt to CalPERS as quickly as possible, helping it avoid the possible fate of other cities. Mendel quotes Modesto’s acting city manager, who told the Modesto Bee “he is hearing that many cities are facing bankruptcy over rising pension costs.” In the case of looming fiscal trouble, most say slashing at debt is a good idea.

But not everyone is so favorably disposed toward the governor’s plan. David Crane, a Stanford University lecturer and president of Govern for California, argues in a column that the plan is terrible precedent that transfers more pension costs from the beneficiaries of the pension system to the state’s taxpayers. When the state makes pension promises to employees, he wrote, both the state and the employees make contributions into the system, which he refers to as “normal costs.”

By contrast, when agencies increase benefit levels or stock-market earnings go down, the pension funds face those “unfunded liabilities,” which are the unfunded promises they’ve already made to current retirees and employees. CalPERS currently is 74 percent funded, which means that 26 percent of those promises are unfunded. “In contrast to joint sharing of normal cost, employees don’t share in the cost of unfunded liabilities,” he wrote. “One hundred percent of that cost falls on citizens, whose services get crowded out and taxes get raised to pay off the liabilities.”

Borrowing these taxpayer funds to pay off the pension debt, he explains, would just let CalPERS continue to set these shared “normal costs” at an unfairly low rate. Furthermore, Crane notes that this special fund is funded entirely by taxpayers, so he fears the state will borrow from other special funds. The state could claim that these monies are going to pay for public services, when in reality they are being siphoned off for pensions.

As Gov. Arnold Schwarzenegger’s pension adviser, Crane wrote that he helped the former governor “engineer ‘Deficit Reduction Bonds’ as a way to address the deficit he acquired upon taking office.” But he now regrets the move: “Those borrowings didn’t solve anything. They just covered up the problem, with interest to boost.”

State and local governments are understandably in a bind. They have “few ways to slow the rapidly climbing cost, among them: cut staff and services, lower pensions for new hires, get unionized employees to pay more for their pensions or cut salaries …,” explained Mendel. He noted the key obstacle limiting the ability of governments to cut pension accruals in the future is something called the “California Rule,” which is making its way to the state Supreme Court.

For some, then, shuffling funds around to prepay a little pension debt seems like a cost-free no-brainer to likely limit the growth of the debts. But to others, it’s just a shell game that evades the more politically dangerous course of tackling the size of those benefits head on – and running into powerful resistance from the state’s public-employee unions.

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

Last week, a three-judge panel of the fourth state appellate court district unanimously rejected a 2015 PERB ruling that if upheld would have invalidated a successful 2012 San Diego ballot measure that gave newly hired city employees – except for police officers – 401(k)-style retirement benefits instead of defined-benefit pensions. The measure was meant to dig California’s second-biggest city out of a hole created by two City Council decisions to intentionally underfund the San Diego pension system, leading to a city fiscal crisis so severe that San Diego was dubbed “Enron-by-the-Sea” in 2004 by the New York Times.

PERB’s ruling was based on the view that any pension ballot measure that was promoted by elected city officials – in San Diego’s case, by then-Mayor Jerry Sanders and several City Council members – ran afoul of state requirements that local governments had to negotiate in the standard collective bargaining “meet and confer” process before they could change terms of employment.

This legal argument was tough to square with California’s history. Elected officials frequently have taken the lead in employing direct democracy to adopt new laws or modify existing ones – including those that affect terms of employment for public employees. In 2005, for example, Gov. Arnold Schwarzenegger sought to change teacher tenure rules in a special election. Schwarzenegger couldn’t sell the change to voters, but his attempt to do so was not seen as unlawful or unusual.

The appellate panel agreed with the city of San Diego’s argument that while elected officials helped lobby for the 2012 pension reform measure, it was crafted and placed on the ballot in keeping with standard practices for citizens’ initiatives, with petition committees, signature-gathering campaigns and other normal trappings of direct democracy. The ruling also noted that PERB had tried to use its official powers to block the ballot measure in early 2012 even before it reached the ballot, with the hint that appellate judges saw this decision as a sign of PERB abusing its authority.

PERB wanted collective bargaining to apply retroactively to older laws

PERB’s previous setback in asserting the sweeping powers of collective bargaining laws came in its response to a lawsuit filed in 2011. Parent activists sued the Los Angeles Unified School District for not considering student performance when formally evaluating teachers, as is required by the Stull Act, a far-reaching state education blueprint enacted in 1971.

PERB contended that before teachers were subject to such evaluations, the matter should be collectively bargained – even though the primary law establishing collective bargaining for teachers was approved in 1975, four years after the Stull Act took effect. The agency also held that it should have initial jurisdiction over the case – not state courts.

But Los Angeles Superior Court Judge James C. Chalfant’s 2012 decision categorically rejected PERB’s arguments, saying that LAUSD could not ignore the Stull Act’s requirements, that collective bargaining did not apply retroactively to older state laws and that parent activists were free to use the courts to challenge whether public schools were complying with state laws.

The Stull Act remains an area of contention for California public schools despite Chalfant’s ruling. In September, Contra County Superior Court Judge Barry P. Good rejected a lawsuit that said 13 Northern California school districts were breaking state law by refusing to consider student performance in evaluating teachers.

Good’s 40-page ruling held that the Stull Act’s requirements were not as “clear and unambiguous” as those who filed the lawsuit contended.

Legislators have largely avoided the pension issue since passage of a reform law that went into effect in 2013, and reformers have struggled to settle on an initiative strategy to take to voters. That’s unlikely to change. But last week the high court agreed to review a union appeal of a decision involving an obscure concept known as the California Rule. The decision could change everything.

The California Rule is not actually a rule, but a legal doctrine that emanated from a 1955 court case. Essentially, it states that no vested public-employee benefit such as a pension can be reduced unless public employees are granted another benefit of equal or greater value. Unions claim that a 2013 state law unfairly deprives them of vested benefits.

The rule remains the stumbling block for most efforts to reduce pension costs, given that it severely limits public agencies’ efforts to slice current pension costs. Hence, pension reformers and unions alike are eager to get a final verdict on the matter.

In the private sector, companies that offer defined-benefit pension plans – those plans that guarantee a pension payout based on a formula, as opposed to 401(k)s – are free to reduce the benefits going forward. In other words, employees must be made whole through today, but may start receiving lower benefits tomorrow. By contrast, in California and other states that follow this rule, government workers must be paid the full amount of the promised benefits until they (and their spouses) pass away.

The accepted interpretation has been that a benefit hike, once approved by a government agency, is permanent. It can never be rolled back. As a result, most pension reform proposals deal only with shaving benefits for new hires, who won’t start retiring for 25 or 30 years. That leaves service cuts and tax hikes as the only way to deal with increasing pension debt.

Some localities have tried to take on the rule. In 2012, for instance, San Jose officials put a pension-reform measure on the ballot that required current city employees to choose between new pension plans that offered fewer benefits than current plans. It passed with 70 percent of the vote, but the courts later gutted that measure. They relied on the California Rule.

But now the California Supreme Court is ready to address the issue, at least around the margins. Last week, the court, without comment, agreed to a union challenge of a San Francisco appeals court that put limits on the application of the rule. Last summer, unions appealed a similar Marin County case, in which an appeals court also put some limits on the rule’s application.

At issue is the California Public Employees’ Pension Reform Act, which went into effect in January 2013. Most analysts viewed the law as a modest attempt to get control of the state’s growing unfunded pension liabilities, or debt. Most of it applied only to newly hired state workers. But it did include a handful of provisions that affect current workers.

On Dec. 30, the First District Court of Appeal in San Francisco rejected a challenge by a state firefighters’ union claiming that PEPRA’s elimination of a 2003 benefit that let firefighters purchase up to five years of additional credits (airtime) before retiring was in violation of the rule.

“The unions argued that their members had a legal right to the pension benefits that were in effect when they were hired and that the state broke its contractual promise to them by eliminating those benefits,” according to a San Francisco Chronicle analysis. The 3-0 written opinion found that public employees have a right to a “reasonable pension” but they aren’t guaranteed “fixed or definite benefits immune from modification or elimination.”

“(P)laintiffs assert a vested contractual right to purchase up to five years of airtime service credit that is not subject to elimination or destruction by legislative amendment or repeal ‘even before the benefit has been accessed or the time for retirement has arrived.’” The court said plaintiffs “disregard the fact that, when amending the statutory scheme governing pension rights, the Legislature in fact provided (eligible public employees) … a several-month window in which to purchase the airtime service credit before the option terminated.”

The high court could uphold the rule or overturn it, or put certain limits on its application and deal narrowly with the “airtime” issue. In that separate Marin County case, five unions challenged PEPRA’s limitation of various ways that public employees enhance, or spike, their end-of-career salaries (bonuses, unused leave, etc.) to boost their lifetime retirement pay.

Unions argue that the reform reduced their vested pension benefits and was therefore in violation of their constitutional rights, as upheld by – you guessed it – the California Rule. “(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,” ruled Justice James Richman, in language similar to the San Francisco ruling. He wrote that the Legislature may “prior to the employee’s retirement, alter the formula, thereby reducing the anticipated pension.”

As reporter Ed Mendel has explained in Calpensions, “The high court will wait until an appeals court rules on three similar spiking ban suits consolidated from Alameda, Contra Costa and Merced counties.” That might take some time, but this issue is definitely coming to the state’s high court in one form or another, sooner or later.

Battle lines are drawn. The unions claim that state and local agencies may not reduce any pension benefits. Pension reformers – and the courts, in recent decisions – say that while a reasonable pension remains a right, that doesn’t stop localities from reducing some things. These cases deal with pension-spiking enhancements and the purchase of airtime – controversial and somewhat limited practices. But the future of pension reform is on the line.

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

This end-of-year board vote to reduce expected investment returns from 7.5 percent to 7 percent portends difficulties for local agencies that provide pensions to their public employees through the CalPERS system. Lowered earnings estimates mean these agencies will have to contribute significantly higher payments to the pension fund to defray the costs of these benefit packages. In 2012, CalPERS dropped its expectations from 7.75 percent to 7.5 percent.

“The three-year reduction of the discount rate will result in average employer rate increases of about 1 percent to 3 percent of normal cost as a percent of payroll for most miscellaneous retirement plans, and a 2 percent to 5 percent increase for most safety plans,” according to a CalPERS statement following the vote. The “normal” cost doesn’t address the growing size of the fund’s unfunded liabilities (i.e., debt), so local governments will also have to boost their “unfunded accrued liability payments” by as much as 30 percent to 40 percent.

California local governments already have faced 50-percent hikes in their CalPERS payments over the past several years, which has led local officials and pension reformers to increasingly fear a continuing cycle of service cut-backs and tax increases. Indeed, there was some pressure at CalPERS to push the expected return rates down to the 6 percent range, but some officials expressed concern about what this would mean, cost wise, for member agencies.

“The reduction in the rate of return is not as big as was discussed last month,” according to a Dec. 21 report in Pensions & Investments. “Chief Investment Officer Theodore Eliopoulos said at last month’s finance and administration committee meeting that given diminished investment return assumptions over the next decade, 6 percent was a more realistic return for the coming 10 years. Andrew Junkin, president of Wilshire Consulting, which serves as CalPERS’ general consultant, said at the November meeting that Wilshire was predicting an annual return of 6.21 percent for the next decade, down from its estimates of 7.1 percent a year earlier.”

Even a 6 percent expected rate of return would be overly aggressive, according to many pension-reform advocates who note that CalPERS received a 0.6 percent return last fiscal year – and 2.75 percent in the previous fiscal year. Furthermore, beginning in 1999, the state and most local agencies began a spree of retroactive pension increases.

These massive benefit hikes – oftentimes 50 percent or more – put additional strain on the system. Critics call for CalPERS to embrace rate returns that are considered risk free – i.e., tied to the Treasury bond rate. That would mean an expectation of about 3 percent a year for the coming decade.

The burden falls mainly on local governments, but public employees hired after a 2013 pension-reform measure (the Public Employees’ Pension Reform Act, or PEPRA) will face higher personal contributions to their pension plan. Because of something known as the “California Rule,” the state’s public employees cannot be forced to increase their contributions or receive fewer benefits than promised – but that doesn’t apply to those hired under a new set of rules. (A court decision last year opened the door to reduce benefits for current workers, but that case has yet to be resolved.)

Few California cities will face what is taking place in Loyalton, a tiny Sierra County town west of Reno, Nevada. The town could no longer afford to pay its fees to CalPERS, and the fund has threatened to cut off its four retirees’ pensions. As Calpensions explained, “According to a state controller’s report for 2015, Loyalton had revenues of $1.17 million, expenditures $1.68 million, liabilities $6.16 million, assets $11.1 million, fund equity $4.8 million, and population 733.”

This is an extreme version of the stress faced statewide, a problem exacerbated by the fact that the pension fund will soon have more retirees collecting pensions than active workers paying into the system. That situation wouldn’t be a problem if the system were entirely sustainable – i.e., if it weren’t amassing unfunded liabilities.

Gov. Jerry Brown applauded CalPERS’ decision to reduce its assumptions. “Today’s action by the CalPERS Board is more reflective of the financial returns they can expect in the future. This will make for a more sustainable system,” the governor said in a Dec. 21 statement.

These debates over the “rates of return” are so significant because of the way CalPERS and other defined-benefit systems operate. In defined-contribution systems (401/k-style systems, for instance) typical in the private sector, employees contribute a portion of their income into their retirement fund. Employers often match a certain percentage of these contributions. The money is invested in, say, a mutual fund. If the returns are high, the employee gains more retirement income. If they are low, the employee receives less. There are no future liabilities.

By contrast, public employees receive a promised benefit level determined by a formula based on years worked and a percentage of salary. Pension funds invest the money and their investment returns help assure the system has enough cash to meet all the current and future promises. If investment returns sag (or benefits are increased), the funds incur large unfunded liabilities or debts. Ultimately, the state’s taxpayers are responsible for any shortfalls. So the expected rate of return carries enormous public-policy implications for the state and municipalities.

Critics complain that the CalPERS board is comprised largely of public employees, retirees and elected officials with close ties to public-employee unions, which provides a strong incentive to push funding problems further into the future. But even with that dynamic there’s only so much that can be done in a world of weak investment returns and stepped up accounting standards. Efforts by CalPERS’ investment staff and board members – and by the Brown administration – to deal more realistically with the issue is viewed by most Sacramento observers as an encouraging sign.

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

New laws going in effect

Good morning. Happy Hump Day. Your Morning Read author just flew back from D.C. last night from a holiday visit. But we’re back online, with the new year, and new laws, rapidly approaching.  

Gov. Jerry Brown signed 898 bills into law last year. Most start on Jan. 1, but others are going into effect in coming years. The majority of new laws deal with minutiae that’s unlikely to affect most residents, but a number of them will have real-world consequences for broad numbers of people – on issues ranging from new driving rules to patients’ access to experimental medications.

CalWatchdog has a sampling of some of the significant new laws from last session, which range from legalized lane splitting, to registering ammo purchases, to higher minimum wages and unpaid leave. 

In other news:

• Speaking of stricter gun and ammo laws: “(S)ales of semi-automatic rifles have more than doubled in California over last year,” reports the The San Jose Mercury News/AP. 

• Pensions: “The California Public Employees’ Retirement System has not had a good 2016. Its investment returns were microscopic, it faced sharp criticism from a prominent financial website for alleged unethical behavior and Gov. Jerry Brown had to intervene to prevent the nation’s largest pension fund from continuing to enable late-career pension spiking by public employees. 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.” CalWatchdog has more. 

• Ghost Ship Fire: “A review of public inspection records, city emails and interviews shows that the city of Oakland for more than a decade often failed to conduct safety inspections on illegally converted warehouses, even those that were well known. Without the inspections, the city could not require owners to bring the building up to code or force the residents out.” The Los Angeles Times has more.  

• Water: “The Sierra Nevada snowpack remains almost 30 percent below average for this time of year despite a boost from the weekend storm, state water officials reported Tuesday, as agencies begin snow surveys by hand throughout the mountain range.” The San Jose Mercury News has more. 

Legislature:

• Gone till January. 

Gov. Brown:

• No public events announced. 

Tips: matt@calwatchdog.com

Follow us: @calwatchdog @mflemingterp

New follower: @JakeSaltzman1

U.S./Mexico water negotiations closely watched

Good morning. Happy Hump Day. A deal between the U.S. and Mexico on how to apportion Colorado River water in drought conditions expires next year and negotiators are in overdrive to renew the pact before President Barack Obama leaves office on Jan. 20.

The talks are being closely watched by California officials. The Golden State relies heavily on Colorado River water, with an entitlement to 4.4 million acre-feet a year. That’s enough to supply nearly 9 million households, though a big chunk of the supply is used to irrigate the hundreds of square miles of agricultural fields in Imperial County (pictured) and the Coachella Valley.

Why the rush? Because U.S. and Mexican officials believe a new deal is crucial to preserving fragile Colorado River supplies. 

CalWatchdog has more. 

In other news:

• “California officials are pushing back on SEIU Local 1000’s plans for a one-day strike next week, warning employees that they could be subject to disciplinary action if they participate in what the state regards as an unlawful walkout,” writes The Sacramento Bee.

• “The state Supreme Court last week agreed to hear an appeal of a groundbreaking ruling that allows cuts in the pensions earned by current state and local government workers, including judges,” reports Capitol Weekly. 

• “A San Francisco supervisor is proposing more money for lawyers to defend immigrants who face possible deportation under a Trump administration. KCBS radio reports that San Francisco Supervisor David Campos will introduce legislation Tuesday setting aside $5 million from the city’s budget to help pay for lawyers to represent people in deportation proceedings.” The Los Angeles Times/Associated Press has more. 

• And in case you missed it: What a Democratic supermajority in the Legislature in the upcoming session may mean for the state. CalWatchdog has more. 

Legislature:

• Gone till December.

Gov. Brown:

• No public events announced. 

Tips: matt@calwatchdog.com

Follow us: @calwatchdog @mflemingterp

New follower: @richardsstarr

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.

Escalating pension debt may rest on CA Supreme Court ruling

Good morning. Happy Hump Day. While it seems everyone is trying to get footage of Trump speaking candidly in recordings of “The Apprentice,” which we’ll call the “Trump tapes,” we start this morning with some pension news.

A decision by four Marin County public-employee associations to appeal a pension-related case to the California Supreme Court could ultimately determine whether localities have the tools needed to rein in escalating pension debt.

At issue is how far officials can go to reduce some benefits for current employees after a state appeals court has chipped away at a legal “rule” long favored by the state’s unions.

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. …

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. 

CalWatchdog has more. 

In other news:

• “(Secure Choice) has several provisions protecting the state (and employers, which are required to enroll employees into Secure Choice) against liability. … To protect against losses, the state plans to invest in low-risk securities, like treasury bonds or the federal MyRA program, while another section in the law allows for the state to adopt recommendations that address “risk-sharing and smoothing of market losses and gains.” CalWatchdog has more. 

• “Feminist attorney Gloria Allred, who has represented an army of women in legal actions against rich and powerful men — Bill Cosby, Tiger Woods, Anthony Weiner and ex-Clippers owner Donald Sterling among them — is demanding the release of footage from Donald Trump’s reality show, ‘The Apprentice,'” reports Politico. 

• “When Palo Alto software entrepreneur Ron Unz led a campaign to ban bilingual education 18 years ago, California erupted in an acrimonious debate that drew national attention, with proponents expressing fears about the decline of English and opponents charging racism and predicting an educational Armageddon. But today, in a sign of the Golden State’s dramatically changing demographics and politics, the campaign to roll back the “English-only” Proposition 227 seems low-key and uncontroversial, overshadowed by a bevy of hot-button ballot initiatives and the emotionally charged presidential race,” writes The San Jose Mercury News. 

• “Opponents of Donald Trump have launched a crowdfunding effort to raise cash that could cover the legal costs of unveiling more lewd video featuring the GOP presidential candidate,” reports LA Weekly. 

Legislature:

• Gone ’til December.

Gov. Brown:

• No public events announced.

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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.