As local governments scrambled to meet a Jan. 1 reform deadline for giving lower pensions to some new hires, a top target was a big increase bargained by police and firefighters during the last decade.
A CalPERS-sponsored bill, SB 400 in 1999, gave the California Highway Patrol a 50 percent pension increase. Then in labor negotiations, local governments were urged to match the new benchmark as a way to remain competitive in the job market.
The landmark bill also gave all state workers a large retroactive pension increase. And retirees received a 1 to 6 percent increase in their pensions. All this could be done, said a CalPERS brochure given to legislators, without costing taxpayers “a dime.”
When critics say pension costs are “unsustainable,“ they often cite the SB 400 increase along with below-forecast investment earnings. Frequently mentioned: Police and firefighters retiring at age 50 with 90 percent of final pay after serving 30 years.
The California Public Employees Retirement System no longer claims that “superior” investment returns cover all SB 400 costs. But CalPERS does not view benefits as a key driver of pension costs, pointing instead to rising pay and market cycles.
Gov. Brown’s pension reform, which took effect Jan. 1, resulted in new and narrow calculations of how higher pensions increase annual costs paid by local government employers.
The bill, AB 340, ended bargaining for higher pensions and imposed a single statewide formula for new hires, lower in most cases than the pension formulas used before the SB 400 increase.
But the employer’s formula for new hires before Jan. 1 is used if the employee, through a previous employer, is already a member of CalPERS, the California State Teachers Retirement system or one of the 20 county systems operating under a 1937 act.
Although a few missed the Jan. 1 deadline, CalPERS said 135 local governments successfully scrambled to lower their new-hire pension formulas, more than a third cutting the SB 400 formula that spread to local police and firefighters.
One example of the cost of higher pensions surfaced in an unusual way. Bucking the trend, Antioch scrambled to reverse a cut in the police formula adopted shortly before the last-minute pension reform legislation abruptly appeared in late August.
The police chief persuaded the Antioch city council that restoring the SB 400 formula would give the city a competitive edge and help attract experienced police officers, needed to guide rookies as cuts in the police force are restored.
Antioch originally had the SB 400 pension formula: 3 percent of final pay for each year served at age 50. The cut dropped the formula for new hires to “3 at 55,” still well above the original Highway Patrol formula before the SB 400 increase: “2 at 50.”
CalPERS told Antioch that reversing its cut would add $4,502 a year to the pension cost of a typical police officer. The “3 at 55” annual pension cost, $23,054, would increase under the “3 at 50” formula to $27,556.
One of the few, if not only, attempts to calculate the broad state cost of SB 400 came as pensions moved into the spotlight during the financial crisis. To respond to growing criticism, CalPERS created an aptly named website, “CalPERS Responds.”
A chart labeled “Breakdown of the Change in State Contributions between 1997-1998 and 2009-2010” attributed 51 percent of the increase in state CalPERS payments to higher pay, 27 percent to SB 400 and 8 percent to other benefit changes. (See chart here.)
It was a period of extreme highs and lows. A booming stock market gave CalPERS a brief surplus around 1999, apparently producing the optimistic view that investment earnings would cover much of the cost of the SB 400 pension increase.
As often happens with public pension funds, being fully funded at 100 percent or more resulted not only in a pension increase for employees but also in a contribution “holiday” for employers.
The powerful CalPERS board, which sets an annual rate the state must pay, dropped the state contribution from $1.2 billion in 1997-98 to $160 million in 1999-00, the year SB 400 was enacted.
The state contribution to CalPERS, held down for six years during the time of plenty, did not go back up to $1.2 billion until 2002-03, three years after SB 400. This year the state contribution to CalPERS is $3.7 billion.
One of the puzzling things about the pie chart showing state contribution changes during the decade is the small slice for investment earnings, which are expected to provide about two-thirds of CalPERS revenue.
Investment gains and losses are lumped with demographics and actuarial methods and assumptions for a combined 14 percent of the changes. CalPERS had huge losses during a decade ending in a recession, a global financial crisis and a stock market crash.
The CalPERS investment fund peaked at $260 billion in the fall of 2007, then plunged for a year and a half before finally bottoming out at $160 billion in March 2009. The fund is about $254 billion this week, still below the peak reached five years ago.
In a Wilshire report last year, CalPERS investment earnings ranked at the bottom among public pension funds with more than $10 billion in assets during a five-year period ending Dec. 31, 2011, averaging 0.57 percent compared to 6.12 percent for top funds.
Part of the reason CalPERS investment earnings were a small part of contribution changes during the decade ending in fiscal 2009-10 is a radical “smoothing” period that spreads asset gains and losses over 15 years, well beyond the usual three to five years.
It’s probably no coincidence that CalPERS adopted 15-year smoothing in 2005, when former Gov. Arnold Schwarzenegger briefly backed a proposed ballot measure to switch all new state and local government employees to a 401(k)-style plan.
Smoothing and other CalPERS actuarial policies avoid rate “shock,” a sharp increase in employer contributions. A big jump in pension costs, particularly when other government programs are being cut, is a prime argument for radical pension reform.
But another argument is that making pension costs more predictable and taking a smaller budget bite during hard times aids government employers, if delaying or phasing in needed rate increases does not undermine long-term pension funding.
Smoothing is not the main issue for critics who contend the CalPERS earnings forecast is too optimistic, concealing massive debt. The CalPERS response is that the earnings over the last two decades hit the target, averaging 7.5 percent.
So why is CalPERS only 70 percent funded?
The CalPERS chief actuary, Alan Milligan, mentioned three factors when asked the question last fall: starting the 20-year period with a shortfall, big gains in the first half that led to reduced contributions, and pension benefit increases.
“It’s not that big of a jump,” Milligan said of the cost of SB 400 and other smaller pension increases. “But certainly in combination with the other two (factors) that is a part of it.”
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 http://calpensions.com/