Missing pieces in Brown’s pension reform plan

A bill that started out as Gov. Brown’s proposal to restructure the CalPERS board emerged from the Legislature last week as a more modest change: a requirement that CalPERS board members receive 24 hours of education in pension fund operations.

A 12-point pension reform proposed by Brown in October 2011 called for more “independence and expertise” on the CalPERS board. The governor’s appointees would have doubled to six, matching the number of labor representatives.

The state CalPERS contribution was $1.2 billion in 1997, dropped to less than $160 million in 1999 and 2000, before rebounding after four low years to nearly $1.2 billion in 2002.

“In the past, the lack of independence and financial sophistication on public retirement boards has contributed to unaffordable pension benefit increases,” said No. 11 of the governor’s 12-point plan.

The “unaffordable” pension increases were not identified. But the reference may have been to two bills backed by the powerful CalPERS board, which sets annual rates that must be paid by government employers in the giant retirement system.

When a booming stock market gave pension funds a surplus, a CalPERS sponsored bill, SB 400 in 1999, sharply boosted Highway Patrol pensions and authorized the same pension formula for local police, which many obtained through bargaining.

For state workers, SB 400 rolled back a pension cut given new hires earlier in the decade. Low pensions earned under the old plan could be boosted through a “buy back” with increased contributions. Retirees received a 1 to 6 percent pension increase.

A second bill, AB 616 in 2001, authorized three escalating pension formulas for local governments in CalPERS and 20 county systems operating under a 1937 act. The top formula, “3 at 60,” provides 120 percent of pay after 40 years of service at age 60. (See table at bottom)

The bill the Senate sent to the governor last week, AB 1163 by Assemblyman Marc Levine, D-San Rafael, requires the CalPERS board to adopt a policy that gives board members 24 hours of education every two years.

The CalPERS board, rejecting the advice of its chief actuary, encouraged local governments to boost pensions authorized under AB 616 by offering in 2001 to inflate the value of their pension fund investments to help cover the increased cost.

While boosting pensions, the CalPERS board sharply cut employer rates. The state CalPERS contribution was $1.2 billion in 1997, dropped to less than $160 million in 1999 and 2000, before rebounding after four low years to nearly $1.2 billion in 2002.

Now CalPERS is underfunded and has imposed three rate hikes in the last two years. The last valuation (as of June 30, 2012) showed CalPERS had about 70 percent of the projected assets needed to pay pension obligations over the next three decades.

What would the CalPERS funding level be if a more “independent and expert” board had not raised pensions and cut employer contributions as the funding level went above 100 percent during good economic times?

CalPERS has not done the calculation. But an example of the impact of spending down a brief pension fund surplus comes from the California State Teachers Retirement System, which also cut contributions and raised pension benefits around 2000.

If the boom-time changes had not been made and CalSTRS still operated as in 1990, the funding level would have been 88 percentinstead of 67 percent, the CalSTRS actuary, Milliman, reported last year.

Among the topics that may be included, said the bill, are “fiduciary responsibilities, ethics, pension fund investments and program management, actuarial matters, pension funding, benefits administration.”

A huge CalSTRS rate increase signed by the governor last month, which will squeeze school funding with a $5 billion increase over the next seven years, could have been sharply reduced by better management, possibly even avoided.

The bill the Senate sent to the governor last week, AB 1163 by Assemblyman Marc Levine, D-San Rafael, requires the CalPERS board to adopt a policy that gives board members 24 hours of education every two years.

Among the topics that may be included, said the bill, are “fiduciary responsibilities, ethics, pension fund investments and program management, actuarial matters, pension funding, benefits administration.”

A similar policy for 20 county retirement systems operating under a 1937 act was enacted (AB 1519) two years ago. As it turns out, the CalPERS board already has a similar policy.

“We have recently adopted a board member training and education policy,” Danny Brown, a CalPERS lobbyist, told a Senate committee hearing on AB 1163 last month. “This bill is consistent with that.”

The bill originally contained Brown’s proposal to add two appointees of the governor, “independent” with “financial expertise,” to the 13-member CalPERS board and replace the Personnel Board representative with the governor’s finance director.

Levine, a freshman who defeated a union-backed candidate, introduced the bill on his own initiative. The proposal would have needed voter approval because of a labor-backed constitutional amendment in 1992 protecting CalPERS independence.

Public employee unions opposed the hybrid plan. With the 401(k)-like part of the plan, employees would share the risk of poor investment returns, which under a pension plan is only borne by the employer.

A legislative analysis of the reform based on Brown’s 12-point plan, AB 340 in 2012, said “the governor chose to drop the CalPERS board issue.” His modest state worker retiree health care cut was dropped by legislators, who said it should be bargained.

The analysis said the governor’s proposal to give new hires a “hybrid” plan, combining a smaller pension with a 401(k)-style investment plan, was replaced by a cap on the amount of pay used to calculate pensions.

For new hires, pensionable pay is capped at the maximum earnings amount taxed for Social Security, $117,000 this fiscal year, or at 120 percent of that amount if the retiree does not receive Social Security.

The failure to include a hybrid plan was mentioned by some critics when CalPERS estimated that the reform legislation would only save $12 billion to $15 billion over the next 30 years, when adjusted for inflation.

Public employee unions opposed the hybrid plan. With the 401(k)-like part of the plan, employees would share the risk of poor investment returns, which under a pension plan is only borne by the employer.

Brown’s proposed hybrid was intended, with Social Security, to replace 75 percent of salary after 35 years of service for most employees. For police and firefighters, the goal was replacement of 75 percent of salary after 30 years on the job.

The reform legislation covering CalPERS and the 20 county systems, but not big-city plans, imposes standard pension formulas on new hires that are lower than the generous formulas in SB 400 and AB 616. They encourage retirement at a later age.

For example, most state workers hired before the reform took effect on Jan. 1, 2013, have a “2 at 55” formula that replaces 50 percent of salary at age 63 with 20 years of service, 75 percent at 63 with 30 years and 100 percent at 63 with 40 years.

Most new state workers have a “2 at 62” formula that provides the same salary replacement with the same years of service, but not until the worker reaches age 67. (See tables below) Most state workers receive Social Security in addition to the CalPERS pension.

The “3 at 50” formula given the Highway Patrol by SB 400 is capped at 90 percent of salary at age 50 after 30 years of service. The formula was widely adopted by local police and firefighters and is often cited as an example of “unsustainable” pensions.

The top reform formula for new police is “2.7 at 57,” replacing after 30 years of service 60 percent of salary at age 50 and 81 percent at age 57. The new formula is uncapped and replaces 108 percent of salary at age 57 after 40 years of service.

Other parts of the reform legislation call for a 50-50 split of pension normal costs between employers and employees (employers still pay for all of the debt or unfunded liability), crack down on pension spiking and prohibit cuts in contributions during boom years.
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Ed’s Note:  Reporter Ed Mendel covered the Capitol in Sacramento for nearly three decades, most recently for the San Diego Union-Tribune. More stories are at Calpensions.com.