Public pension changes take effect

Gov. Brown pushed through legislation that cuts and caps public pensions for new employees, making a fix-it-to-save-it argument while bypassing the bargaining usually demanded by his labor allies for benefit changes.

Voters needed assurance the governor’s tax hike on the November ballot would not be eaten up by pension costs, and inaction might fuel an initiative drive for radical change, possibly a switch to a 401(k)-style plan.

Brown said the pension reform bill that took effect Jan. 1 was “the biggest rollback of public pensions in California history,” a package that will “save tens of billions of taxpayer dollars” and make pensions “more sustainable.”

How does the bill pushed by a Democratic governor through a Demococratic-controlled Legislature compare with the pension reform efforts of two Republican governors, Pete Wilson and Arnold Schwarzenegger?

Here’s some recent history, beginning with a pro-and-con look at the condition of public pensions.

Pension critics said Brown’s bill is a “small” or “first” step. Much more needs to be done to cut the pension debt or “unfunded liability.” As in the private sector, pensions earned by current workers for future work must be trimmed, even if it takes a court battle.

One of the fastest-growing government costs, retiree health care, needs to be cut and pre-funded like pensions, so investment earnings can cover future costs. Underfunded CalSTRS needs legislation to get more money from employers and perhaps teachers.

The bill does not contain Brown’s proposal for a federal-style “hybrid” combining a smaller pension with a 401(k)-style plan, which makes employees share some of the investment risk now borne only by employers and taxpayers.

It’s only legislation, not a constitutional amendment approved by voters. Future legislation can slowly chip away at cost-cutting reforms or erase them all with one swift end-of-session deal.

Relief is needed for independent big-city pension systems that, with their high personnel costs, are on the bleeding edge of high pension costs. But the legislation only covers CalPERS, CalSTRS and 20 county systems operating under a 1937 act.

Voter-approved measures in San Jose and San Diego, desperate attempts to cut current worker costs, may be tied up in court for years. Los Angeles projects soaring retirement costs but seems politically paralyzed, as if zombified, a walking dead man.

Bankruptcies in Stockton and San Bernardino, as in Vallejo before them, seem unlikely at this point to result in much if any pension-cost relief, even for cities that have slashed vital police and firefighter services.

Pension supporters have a different view. After a major market crash and recession, CalPERS and CalSTRS still have roughly 70 percent of the projected assets needed for future obligations, a funding level not regarded as dangerously low by many.

Payments to CalPERS for state workers, $3 billion in fiscal 2008-90 when the stock market crashed, are $3.7 billion this year, thanks to increased worker contributions and a loose actuarial policy, which may be tightened if an economic upturn continues.

CalSTRS finally got legislators to consider a funding solution. Three options are due Feb. 15. Unlike most pension funds, CalSTRS lacks the power to set employer rates. And without a rate increase, it’s said to be on a path to run out of money in three decades.

The pension debt or “unfunded liability,” which balloons to eye-popping levels when “unrealistic” earnings forecast are lowered, is overrated as a gathering cloud of fiscal doom. It’s a debt of uncertain size that may or may not have to be paid.

Unlike stable bond debt, the pension “unfunded liability” can have huge swings, up or down. It’s the gap, over 30 years, between two moving targets: the estimates of future pension costs and of future revenue from employers, employees and investments.

The “unfunded liability” is based on what’s needed for 100 percent funding in 30 years, a seldom-reached goal and a mixed blessing. Full funding often creates pressure to cut contributions and raise pensions, which can lead to underfunding again.

The big variable is investment earnings, often expected to provide two-thirds of the revenue. If the 30-year earnings forecast is dropped from about 7.75 percent to 4 percent, as Stanford Graduate students showed, the unfunded liability can balloon tenfold.

But if investment earnings average 16 percent for five years, actuaries said last April, the California State Teachers Retirement System would be fully funded. The unlikely but not impossible earnings would erase a $65.4 billion “unfunded liability.”

The Brown pension bill (AB 340) gives new employees of state and local government in the three systems lower pensions than current workers and requires the new employees to work longer to receive full pension amounts.

Pensions earned by most new hires will be capped at the top salary taxed for Social Security, last year $110,000 and growing with inflation. About 19,000 CalPERS and CalSTRS current retirees receive $100,000 or more, and one peaked at $500,000.

A single pension formula ends labor bargaining for higher pensions, an escalating scale that for California Public Employees Retirement System members in local government provides as much as 120 percent of final pay after 40 years on the job.

The new pension formulas for general and safety workers are a little lower than the formulas used before a major state worker pension increase, SB 400 in 1999, now said by critics to be a key factor in “unsustainable” pension costs.

Brown’s bill makes it more difficult for new hires to boost or “spike” pensions, a crackdown sparked by a report that two Contra Costa fire chiefs retired at ages 50 and 51 with pensions far above their pay — a $185,000 salary and $241,000 pension in one case.

Court rulings are widely believed to mean that pensions promised current workers on the date of hire cannot be cut, unless offset by a new benefit of equal value. But the bill requires some current employees to begin paying more each year for their pensions.

For a third of state workers, pension contributions will increase by 1 to 3 percent of pay to bring them up to the new target. If local government workers are not paying their new share by 2018, an increase can be imposed through a bargaining impasse.

The bill expects employees to pay half the “normal” cost, an amount intended to cover pensions earned during the year. Employers pay the other half and any “unfunded liability” if projections miss targets, now a large debt mainly due to investment losses.

For all employees retiring after Jan. 1, the bill limits “double dipping” (returning to a government job after retiring with a pension), prohibits the purchase of unserved “air time” to boost pensions and allows the elimination of pensions for job-related felonies.

For CalPERS, which covers about half of the non-federal government workers in the state, the bill is expected to save $43 billion to $56 billion over the next 30 years. In present day dollars, the savings are $12 billion to $15 billion.

Former Gov. Wilson pushed through legislation in the early 1990s that gave new state hires a much lower pension and shifted control of the powerful actuaries, who set annual rates that must be paid by employers, from CalPERS to lawmakers at the Capitol.

Wilson also obtained legislation that shifted $1.1 billion from CalPERS inflation-protection funds to the deficit-ridden state general fund. The fund shift was overturned by the courts.

But the big blowback came from public employee unions, who called the shift a “raid” on retirement funds. The unions put a constitutional amendment on the ballot, Proposition 162 in 1992, that strengthened CalPERS and other public retirement systems.

The initiative, approved by 51 percent of voters, gave public pension boards total control of actuaries and all system funds. To prevent lawmakers from tampering with pension boards, a public vote is required to change board composition and operations.

And importantly, in the view of some, providing benefits to retirees was made the top priority of pension boards. Formerly minimizing costs for employers and taxpayers had equal standing with providing benefits to retirees.

When Brown’s first-term chief of staff, Gray Davis, became governor he erased the Wilson pension cut by signing the landmark pension increase for state workers, SB 400 in 1999, that sailed out of the Senate on a 39-to-0 vote.

Now SB 400 is vilified by pension critics as a costly trendsetter, particularly for local police and firefighters, that granted excessive, retroactive benefits the sponsor, CalPERS, misleadingly said would not cost taxpayers “a dime.”

Former Gov. Schwarzenegger’s proposal to close a state budget gap in 2004 included a $949 million bond to help pay pension costs. To pay for the bond, the state stopped making pension contributions for new workers during their first two years.

Pension contributions made by the new workers went into a 401(k)-style investment plan called the Alternate Retirement Program. After two years, the worker contribution automatically switched to CalPERS.

Then workers were given three options for their two years of contributions: take the money in a lump sum, leave the money in a 401(k)-style plan or transfer the money to CalPERS and receive two years of service credit toward a pension.

The CalPERS board was told in June 2010 that 44 percent of the workers failed to make a choice, which left their money in the 401(k)-style plan.

The proposed 20-year pension bond and later smaller versions were never issued, blocked by a taxpayer group lawsuit successfully arguing a vote of the people was needed. Brown’s pension bill ended the Alternate Retirement Program.

Schwarzenegger briefly backed a proposed initiative in 2005 to switch state and local government new hires to 401(k)-style plans. He dropped his support after union-sponsored TV ads said police and firefighters would lose death and disability benefits.

In his last year in office, Schwarzenegger used a record 100-day budget deadlock to get the largest state worker union to agree to raise the pension contributions of current workers and give new hires a lower pension.

Responding to the issue of whether CalPERS investment earning forecasts are too optimistic and conceal massive debt, Schwarzenegger obtained legislation requiring a detailed analysis of employer rate changes and an opinion from the state treasurer.

The nonpartisan Legislative Analyst said the bill was unworkable. Followup legislation last year streamlined the procedure to show what happens short term if earnings are 2 percent below or above the forecast, now 7.5 percent for CalPERS.

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Reporter Ed Mendel covered the Capitol in Sacramento for nearly three decades, most recently for the San Diego Union-Tribune. More stories are at http://calpensions.com/