We’re taking my favorite holiday — the Fourth of July — as an opportunity to rejuvenate for several days.

We may post a headline or two each day if they seem important, but otherwise we hope to be back with full daily news of escalating state and local government pension crises on Monday. – Jack Dean, Publisher

We’re going to celebrate my favorite holiday — the Fourth of July — by taking a few extra days to rejuvenate. We’ll be back with more news of escalating state and local government pension crises on Monday. – Jack Dean, Publisher

The Association of California Cities-Orange County will hold a pension forum Friday in Newport Beach featuring several local leaders.

The discussion of California’s public pension crisis will include state Sen. John Moorlach (R-Costa Mesa), Newport Beach City Councilwoman Diane Dixon, Huntington Beach City Councilwoman Lyn Semeta, Fullerton City Manager Ken Domer, Huntington Beach Assistant City Manager Lori Ann Farrell and Kerry Worgan, chief actuary of the California Public Employees’ Retirement System.

The forum will run from 8 a.m. to noon at the Newport Coast Community Center, 6401 San Joaquin Hills Road. Tickets are $25 for association members and $45 for nonmembers. [Source: Daily Pilot]

Instead of the cross, the albatross
About my neck was hung.
– Samuel Taylor Coleridge, The Rime of the Ancient Mariner, 1798

By Ed Ring | In Coleridge’s famous poem, a sailor who killed an albatross has it hung around his neck as punishment. Since then, the albatross, which sailors used to consider good luck, has come to symbolize an oppressive burden. When it comes to ensuring the financial sustainability of California’s cities and counties, few burdens have become more oppressive than funding employee pensions.

A study issued earlier this month entitled “Pension Math: Public Pension Spending and Service Crowd Out in California, 2003-2030,” by the Stanford Institute for Economic Policy Research, offers comprehensive and visceral proof of just how big the pension albatross has become around the fiscal necks of California’s cities and counties, and how much bigger it’s likely to grow. Recent articles by pension expert Ed Mendel and political watchdog Steve Greenhut provide excellent summaries. To distill the “Pension Math” study to a few ominous and definitive quotations, here are two that describe how dramatically pension costs have eaten into California’s civic budgets:

“Employer pension contributions from 2002-03 to 2017-18 have increased at a much faster rate than operating expenditures. As noted, pension contributions increased an average of 400%; operating expenditures grew 46%. As a result, pension contributions now consume on average 11.4% of all operating expenditures, more than three times their 3.9% share in 2002-03.”

And the fun is just beginning:

“The pension share of operating expenditures is projected to increase further by 2029-30: to 14.0% under the baseline projection—that is, even if all system assumptions, including assumed investment rates of return, are met—or to 17.5% under the alternative projection.”

Back in 2016, the California Policy Center produced a study entitled “The Coming Public Pension Apocalypse, and What to Do About It.” In that study (ref. Table 2-C), the implications of adopting responsible paydowns of the unfunded liability (20 year straight-line amortization which CalPERS is now recommending), are explored, along with various rate-of-return assumptions. Quote:

“A city that pays 10% of their total revenues into the pension funds, and there are plenty of them, at an ROI of 7.5% and an honest repayment plan for the unfunded liability, should be paying 17% of their revenues into the pension systems. At a ROI of 6.5%, these cities would pay 24% of their revenue to pensions. At 5.5%, 32%.”

These are staggering conclusions. Only a few years ago, opponents of pension reform disparaged reformers by repeatedly asserting that pension costs only consumed 3% of total operating expenses. Now those costs have tripled and quadrupled, and there is no end in sight. What can local elected officials do?

The short answer is not much. At least not yet. The city of Irvine provides a cautionary example of how a city did everything right, and still lost ground. In 2013, Irvine’s city council resolved to eliminate their unfunded pension liability in 10 years by making massive extra annual payments out of their reserve fund. As reported in detail last week in the article “How Fraudulently Low “Normal Contributions” Wreak Havoc on Civic Finances,” here is the upshot of what happened in Irvine between 2013 and 2017:

“While the stock market roared, and while Irvine massively overpaid on their unfunded liability, that unfunded liability still managed to increase by 51%.”

There are plenty of ways for California’s cities and counties to get the pension albatross off their fiscal necks, except for one thing. The people who receive these generous pensions (the average pension for a full-career retired public employee in California, not including benefits, was $68,673 in 2015) are the same people who, through their unions, exercise almost absolute control over California’s cities and counties.

Spokespersons for public sector unions scoff at this assertion. “Politicians are mismanaging our cities and counties,” they allege, “blame the politicians.” And of course they’re right. Politicians do run our cities and counties. But these politicians have their campaigns funded by the public sector unions. Even when a majority of city council or county supervisor seats are won by politicians willing to refuse campaign contributions from public sector unions, any reforms they enact are reversed as soon as the unions can reestablish a majority. And if reformers can stay in control of a city or county through multiple election cycles, any reforms they enact are relentlessly fought in court by the unions. Meanwhile, California’s union controlled state legislature enacts law after law designed to prohibit meaningful reform.

This is the reality we live in. Californians pay taxes in order to pay state and local government employees a wage and benefit package that averages twice what private sector workers earn.

Here’s what can be done:

(1) Convince citizens to always vote against any candidate supported by a public sector union.

(2) Convince public sector union officials that the pension crisis is real so at least they will agree to minor reforms. The recent Stanford study, along with the recently introduced CalPERS agency summaries, should provide convincing leverage.

(3) Continue to implement incremental reform either through council action, local ballot measures, or in contract negotiations. They may include:
– lower pension formulas for new employees
– lower base pay in order to lower final pension calculations
– eliminating binding arbitration
For more ideas, refer to Pension Reform – The San Jose Model, Pension Reform – The San Diego Model, and Reforming Binding Arbitration.

(4) Support policies designed to lower the cost-of-living. California’s union controlled legislature has created artificial scarcity in almost all sectors of the economy, driving prices up and providing the justification for public employees to demand wages and benefits that allow them to exempt themselves (but not the rest of us) from the consequences of those policies.

(5) Wait for resolution of two critical court cases. The first is the case Janus vs. AFSCME, challenging the right of government unions to charge “agency fees” to members who opt out of membership. That case is set to be heard by the U.S. Supreme Court in 2018. The second is the ongoing court challenges to the “California Rule.” Attorneys representing California’s government unions claim the California Rule prohibits changing the formulas governing pension benefit accruals even for work not yet performed. California’s Supreme Court is set to hear this case after an appeals court rules on three cases – from Alameda, Contra Costa, and Merced counties. Both of these cases should be resolved sometime in 2018.

The Janus case could decisively lower the amount of money public sector unions currently manage to extract from dues paying public employees, which in California alone is estimated to exceed $1.0 billion per year. A successful challenge to the California Rule would pave the way for real pension reform. Current legal interpretations of the California Constitution bar reductions to pension formulas, even for work that has not yet been performed. This is the so-called “California Rule.” If that interpretation were overturned, pension benefit accruals for future work done by existing employees could be lowered to financially sustainable levels.

All in all, today the pension albatross weighs heavy on the fiscal necks of California’s public agencies, and it’s getting worse, not better. If there were easy answers, the problem would have been solved long ago.

REFERENCES

Pension Math: Public Pension Spending and Service Crowd Out in California, 2003-2030

How pension costs reduce government services, Ed Mendel, CalPensions, 10/09/2017

Forget the scary pension future; study confirms the crisis is hitting now, Steve Greenhut, California Policy Center, 10/10/2017

The Coming Public Pension Apocalypse, and What to Do About It

How Fraudulently Low “Normal Contributions” Wreak Havoc on Civic Finances

What is the Average Pension for a Retired Government Worker in California?

California’s Public Sector Compensation Trends

Average Full Career Pension by City (all CalPERS employers), Transparent California

Public Agency Actuarial Valuation Reports by CalPERS Agency

Pension Reform – The San Jose Model

Pension Reform – The San Diego Model

Reforming Binding Arbitration

[Cross-posted from the California Policy Center.]

By Ken Churchill | There is a lot more to today’s column by Paul Gullixson in the Press Democrat:

1. The supervisors never adopted the pension increase as required by law. Instead, and this the county readily admits, the increase was illegally agreed to in the settlement of a lawsuit between the employee unions and the retirement association. That is one of the many reasons it is very different than the San Rafael case, which was filed by a citizen who was not an attorney and did not make the correct arguments. Fortunately, we have a seasoned trial attorney on our case.

2. The agreement was for the employees to pay for the increase through increased contributions to the pension fund. The current supervisors are fully aware this has not been happening, but have failed to take any action to increase employee contributions to meet the agreement. This means there continues to be an illegal misuse of public funds. After the increase, employee retirement ages dropped by 5 years and retirees received on average an additional $15,000 to $16,000 per year. An annuity for this amount would cost $280,000. Instead of collecting $280,000 from retiring employees, the county had them contribute an additional 3% of pay towards their pension. If someone made the average pensionable salary of $85,000 per year their annual contribution would be $2,550. So they would have to pay the 3% for 109 years to pay for the impact of the increase. Instead, thousands have retired since it was implemented, contributing almost nothing towards their $280,000 annuity.

3. Even if a statute of limitations argument prevents someone from going back more than 3 years, the illegal increases should be stopped going forward. Basically, the retirement association is writing checks for enhancements that are illegal. The county treasurer also needs to stop writing checks to SCERA for the illegal amounts or she is in violation of state law because she is prohibited from making illegal payments for anything.

The issues involved in the case and the text of the lawsuit are available on the New Sonoma home page.

Ken Churchill is a member of the New Sonoma Advisory Committee. He has over 40 years of business and financial management experience as founder, CEO and CFO of a solar energy company and environmental consulting firm. He sold both companies and now grows wine grapes and produces wines under his Churchill Cellars label. For the past three years, Ken has been actively researching and studying the pension crisis and published a report titled “The Sonoma County Pension Crisis: How Soaring Salaries, Retroactive Pension Increases and Poor Management Have Destroyed the County’s Finances.” He is also a contributor and advisor to the California Policy Center.

By Ed Ring | Pension reform in San Jose began in June 2012 when voters, by a margin of 69% to 31%, approved Measure B. Despite overwhelming support from voters, however, this vote triggered a cascade of union funded lawsuits which by 2015 had overturned several of the key provisions of the reform measure. Finally, in August 2015, the San Jose city council passed a compromise resolution that replaced Measure B with a scaled down reform; this was approved by voters in November 2016.

The provisions of this new pension reform measure should be of keen interest to local reformers everywhere in California, because they survived relentless attacks in court. While these reforms may not prove sufficient to completely solve the challenge to adequately fund pension benefits for city workers in San Jose, they are nonetheless significant. San Jose’s current unfunded pension liability now stands at just over $3.0 billion. These reforms are estimated to save $1.7 billion over the next ten years. Here are highlights:

HIGHLIGHTS OF SAN JOSE’S 2016 PENSION REFORM

1 – Voter approval required from now on:
Any retirement benefit – including pensions and retirement healthcare – cannot be enhanced as the result of negotiations between the city council and union leadership, unless those enhancements are first approved by voters.

2 – New employees will be subject to a reformed package of retirement benefits:
Employees hired after the following dates (Police, 8/04/2013; Fire, 1/02/2015; Misc., 9/30/2012) shall be deemed “Tier II” employees, with the following retirement benefits:

Cost sharing: The city shall not pay more than 50% of the normal and unfunded payments due the pension system; this will be phased in by increasing the employee share of the unfunded payment at a rate of 0.33% of additional withholding of their pay per year.
Age of eligibility: Police and firefighters shall be eligible for retirement benefits at age 57; miscellaneous employees at age 62.
Cost of living adjustments: annual COLA increases to pensions shall be limited to the lessor of the CPI index or between 2.0% and 1.25%.
Pension eligible compensation: Final compensation for purposes of calculating the pension shall be based on the average of the final three years of work, and (with some exceptions for police and firefighters) be limited to base pay only.
Cap on pension benefit: Police and fire retiree pensions are capped at 80% of pension eligible salary, for miscellaneous employees the cap is 70% of pension eligible salary.

3 – “Disability” retirements awarded by independent panel.

4 – “Supplemental Payments” discontinued:
Prior to this reform, whenever investment returns in any given year exceeded the target percentage, supplemental payments were made to retirees. This practice took place even when the pension system was carrying a significant unfunded liability. This new provision even bars supplemental payments if the fund eventually exceeds 100% funding, in order to take into account the possibility that subsequent annual returns may again fall short of projections.

5 – Defined benefit retirement healthcare discontinued:
The defined benefit retiree healthcare plan is ended and instead a Voluntary Employee Beneficiary Association (VEBA) is established for new and current Tier 2 employees. The contribution rate will be 4% into the VEBA. Tier One employees can opt-in to the new VEBA, or keep their defined benefit healthcare plan with a contribution rate of 8% of payroll.

6 – Retirement contributions fixed:
Similar in intent to item #4, even if the pension system becomes more than 100% funded, there will be no lowering of the required employee contributions to the fund via payroll withholding – again, to take into account the possibility that subsequent annual returns may again fall short of projections.

7 – No retroactive benefits enhancements:
If retirement benefits are approved by voters, they are only to apply to work performed subsequent to the date of approval. If an employee transfers into a new job with the city that offers better retirement benefits than the job they vacated, these enhancements only apply to their work subsequent to their transfer.

PENSION REFORM – SAMPLE LANGUAGE

Section 1503-A. Reservation of Voter Authority.
(a) There shall be no enhancements to defined retirement benefits in effect as of January 1, 2017, without voter approval. A defined retirement benefit is any defined post-employment benefit program, including defined benefit pension plans and defined benefit retiree healthcare benefits. An enhancement is any change to defined retirement benefits, including any change to pension or retiree healthcare benefits or retirement formula that increases the total aggregate cost of the benefit in terms of normal cost and unfunded liability as determined by the Retirement Board’s actuary. This does not include other changes which do not directly modify specific defined retirement benefits, including but not limited to any medical plan design changes, subsequent compensation increases which may increase an employee’s final compensation, or any assumption changes as determined by the Retirement Board.

(b) If the State Legislature or the voters of the State of California enact a requirement of voter approval for the continuation of defined pension benefits, the voters of the City of San Jose hereby approve the continuation of the pension benefits in existence at the time of passage of the State measure including those established by this measure.

Section 1504-A. Retirement Benefits – Tier 2.
The Tier 2 retirement plan shall include the following benefits listed below. This retirement program shall be referred to as “Tier 2” and shall be effective for employees hired on or after the following dates except as otherwise provided in this section: (1) Sworn Police Officers: August 4, 2013; (2) Sworn Firefighters: January 2, 2015 and (3) Federated: September 30, 2012. Employees initially hired before the effective date of Tier 2 shall be Tier 1 employees, even if subsequently rehired. Employees who qualify as “classic” lateral employees under the Public Employees’ Pension Reform Act and are initially hired by the City of San Jose on or after January 1, 2013, are considered Tier 1 employees.

(a) Cost Sharing. The City’s cost for the Tier 2 defined benefit plan shall not exceed 50% of the total cost of the Tier 2 defined benefit plan (both normal cost and unfunded liabilities), except as provided herein. Normal cost shall always be split 50/50.In the event an unfunded liability is determined to exist, employees will contribute toward the unfunded liability in increasing increments of 0.33% per year, with the City paying the balance of the unfunded liability, until such time that the unfunded liability is shared 50/50 between the employer and employee.

(b) Age. The age of eligibility for service retirement shall be 57 for employees in the Police and Fire Retirement Plans and 62 for employees in the Federated Retirement System. Earlier Retirement may be permitted with a reduction in pension benefit by a factor of 7% per year for employees in the Police and Fire Retirement Plan and a reduction in pension benefit by a factor of 5% per year for employees in the Federated Retirement System. An employee is not eligible for a service retirement earlier than the age of 50 for employees in the Police and Fire Retirement Plan or age 55 for employees in the Federated Retirement System. Tier 2 employees shall be eligible for a service retirement after earning five years of retirement service credit.

(c) COLA. Cost of living adjustments, or COLA, shall be equal to the increase in the Consumer Price Index (CPI), defined as San Jose – San Francisco – Oakland U.S. Bureau of Labor Statistics index, CPI-Urban Consumers, December to December, with the following limitations:

1. For Police and Fire Retirement Plan members, cost of living adjustments applicable to the retirement allowance shall be the lesser of the Consumer Price Index (CPI), or 2.0%.

2. For Federated Retirement System members, cost of living adjustments applicable to the retirement allowance shall be the lesser of CPI or:
a. 1-10 total years of City service and hired after the effective date of the implementing ordinances of the revised Tier 2: 1.25%
b. 1-10 years total years of City service and hired before the effective date of the implementing ordinances of the revised Tier 2: 1.5%
c. 11-20 total years of City service: 1.5%
d. 21-25 total years of City service: 1.75%
e. 26 or more total years of City service: 2.0%

3. The first COLA adjustment will be prorated based on the number of months retired in the first calendar year of retirement.

(d) Final Compensation. “Final compensation” shall mean the average annual earned pay of the highest three consecutive years of service. Final compensation shall be base pay only, excluding premium pays or other additional compensation, except members of the Police and Fire Plan whose pay shall include the same premium pays as Tier 1 members.

(e) Maximum Allowance and Accrual Rate. For Police and Fire Plan members, service retirement benefits shall be capped at a maximum of 80% of final compensation for an employee who has 30 or more years of service at the accrual rate contained in the Alternative Pension Reform Settlement Framework approved by City Council on August 25, 2015. For Federated Retirement System members, service retirement benefits shall be capped at a maximum of 70% of final compensation for an employee who has 35 or more years of service at the accrual rate contained in the Alternative Pension Reform Settlement Framework approved by City Council on December 15, 2015, and January 12, 2016.

(f) Year of Service. An employee will be eligible for a full year of service credit upon reaching 2080 hours of regular time worked (including paid leave, but not including overtime).

Section 1505-A. Disability Retirements.

(a) The definition of “disability” shall be that as contained in the San Jose Municipal Code in Sections 3.36.900 and 3.28.1210 as of the date of this measure.

(b) Each plan member seeking a disability retirement shall have their disability determined by a panel of medical experts appointed by the Retirement Boards.

(c) The independent panel of medical experts will make their determination based upon majority vote, which may be appealed to an administrative law judge.

Section 1506-A. Supplemental Payments to Retirees.

The Supplemental Retiree Benefit Reserve (“SRBR”) has been discontinued, and the assets returned to the appropriate retirement trust fund. In the event assets are required to be retained in the SRBR, no supplemental payments shall be permitted from that fund without voter approval. The SRBR will be replaced with a Guaranteed Purchasing Power (GPP) benefit for all Tier 1 retirees. The GPP is intended to maintain the monthly allowance for Tier 1 retirees at 75% of purchasing power of their original pension benefit effective with the date of the retiree’s retirement. The GPP will apply in limited circumstances (for example, when inflation exceeds the COLA for Tier 1 retirees for an extended period of time). Any calculated benefit will be paid annually in February.

Section 1507-A. Retiree Healthcare.

The defined benefit retiree healthcare plan will be closed to new employees as defined by the San Jose Municipal Code in Chapter 3.36, Part 1 and Chapter 3.28, Part 1. Section 1508-A. Actuarial Soundness (for both pension and retiree healthcare plans).

(a) In recognition of the interests of the taxpayers and the responsibilities to the plan beneficiaries, all pension and retiree healthcare plans shall be operated in conformance with Article XVI, Section 17 of the California Constitution. This includes but is not limited to:

1. All plans and their trustees shall assure prompt delivery of benefits and related services to participants and their beneficiaries;

2. All plans shall be subject to an annual actuarial analysis that is publicly disclosed in order to assure the plan has sufficient assets;

3. All plan trustees shall discharge their duties with respect to the system solely in the interest of, and for the exclusive purposes of providing benefits to participants and their beneficiaries, minimizing employer contributions thereto, and defraying reasonable expenses of administering the system;

4. All plan trustees shall diversify the investments of the system so as to minimize the risk of loss and maximize the rate of return, unless under the circumstances it is not prudent to do so;

5. Determine contribution rates on a stated contribution policy, developed by the retirement system boards and;

6. When investing the assets of the plans, the objective of all plan trustees shall be to maximize the rate of return without undue risk of loss while having proper regard to the funding objectives of the plans and the volatility of the plans’ contributions as a percentage of payroll.

Section 1509-A. Retirement Contributions.

There shall be no offset to normal cost contribution rates in the event plan funding exceeds 100%. Both the City and employees shall always make the full annual required plan contributions as calculated by the Retirement Board actuaries which will be in compliance with applicable laws and will ensure the qualified status under the Internal Revenue Code.

Section 1510-A. No Retroactive Defined Retirement Benefit Enhancements.

(a) Any enhancement to a member’s defined retirement benefit adopted on or after January 1, 2017, shall apply only to service performed on or after the operative date of the enhancement and shall not be applied to any service performed prior to the operative date of the enhancement.

(b) If a change to a member’s retirement membership classification or a change in employment results in an enhancement in the retirement formula or defined retirement benefits applicable to that member, except as otherwise provided under the plans as of [effective date of ordinance], that enhancement shall apply only to service performed on or after the effective date of the change and shall not be applied to any service performed prior to the effective date of the change.

(c) “Operative date” would be the date that any resolution or ordinance implementing the enhancement to a member’s defined retirement formula or defined retirement benefit adopted by the City Council becomes effective.

REFERENCES

City of San Jose, “Alternative Pension Reform Act,” 2016 (full text)
http://sanjoseca.gov/DocumentCenter/View/59737

City of San Jose, Alternative Pension Reform Act Ballot Measure – references for voters, 2016
http://www.sanjoseca.gov/index.aspx?nid=3208

City of San Jose, Framework Agreement summarizing Alternative Pension Reform Act, 2015
http://www.sanjoseca.gov/DocumentCenter/View/46068

City of San Jose, “Sustainable Retirement Benefits and Compensation Act,” 2012 (full text)
http://www.sanjoseca.gov/DocumentCenter/View/5166

City of San Jose, Measure B (Sustainable Benefits and Compensation Act) – references for voters, 2012
http://www.sanjoseca.gov/index.aspx?NID=5187

Ballotpedia – San Jose Pension Modification Agreement, Measure F (November 2016)
https://ballotpedia.org/San_Jose,_California,_Pension_Modification_Agreement,_Measure_F_(November_2016)

Ballotpedia – San Jose Pension Reform, Measure B (June 2012)
https://ballotpedia.org/San_Jose_Pension_Reform,_Measure_B_(June_2012)

San Jose Mercury News, August 25, 2015 – San Jose council approves Measure B settlement
http://www.mercurynews.com/2015/08/25/san-jose-council-approves-measure-b-settlement/

By Robert Fellner | More great examples this week of the importance of transparency in government, all made possible as a result of California’s Public Records Act.

The Press-Enterprise continued their outstanding investigative reporting by following up on our finding that a Riverside utilities dispatcher tripled his salary to nearly $400,000 due to overtime.

In the news story “Riverside officials knew since 2015 about soaring overtime that exceeded some utility workers’ regular pay” the paper dug deeper into the underlying issues, revealing that the practice caused at least some stuff to raise alarm bells years in advance of our report, which unfortunately went unheeded. A slice:

The utility’s large overtime tab in the electric operations division grew steadily beginning around 2012, but it became noticeable in 2015.

In June that year, the emails show that one dispatcher sent colleagues an email with the subject line, “Overtime and REST TIME in DANGER,” in which he proposed they all make suggestions on how to trim overtime costs before management did it for them.

One employee responded: “We have a contract. They have to honor it. … Don’t think stuff up for them.”

In March 2016, Electric Field Manager Ron Cox wrote to Utilities Principal Analyst Shelly Almgren to explain why the electric division had exceeded its overtime budget three months before the end of the fiscal year.

Read the full article here.

In other news, our CalPERS 2016 release received quite comprehensive coverage, as shown below:

Former Solano County Administrator Tops CalPERS Statewide Pension List — Again (Ryan McCarthy / Daily Republic)

Orange County Cities Dominate When It Comes to Paying Retirees More Than $100,000 a Year (Tomoya Shimura & Jeff Horseman / Orange County Register)

Here’s How Former Employees in Long Beach Made $100,000 or More in Pensions Last Year (Andrew Edwards / Press-Telegram)

10 Percent of Pasadena’s Retirees Make $100,000 or More in Annual Pensions (Jeff Horseman / Press-Enterprise)

Torrance, California Ranks in State’s Top 10 Cities With Retirees Receiving Pensions of More Than $100,000 a Year (Nick Green / Daily Breeze)

City of Santa Monica on Top List of Biggest Public Pensions in California (Niki Cervantes / Santa Monica Lookout)

861 Santa Clara County Retired Public Employees Get Pensions of More Than $100,000 Annually (Patrick May / Mercury News)

Thanks to Jack Dean and his Pension Tsunami website for compiling the above.

All of this reporting then led to a fantastic Santa Cruz Sentinel editorial titled “California taxpayers pay high cost for public employee pensions” which observed that:

… something is out of whack in our state, where government pensions, benefits and salaries are far beyond what most working people in the private sector could ever hope for.

A keen observation. While defenders of public pay extol their high pay as a virtue that others should seek to replicate, it is neither fair nor sustainable when that high pay comes at the expense of those earning much less.

Robert Fellner is Research Director for Transparent California.

Public employee unions try to use good years to deflect attention from a growing problem.

By Steven Greenhut | California’s fiscal watchdogs are bracing for the forthcoming press statements from the nation’s largest state-run pension fund, and from the public-sector unions that depend on the system to pay their members’ generous retirement packages.

Expect something to this effect: “The California Public Employees’ Retirement System’s investment earnings for the fiscal year ending June 30 were above 9 percent, reconfirming the health of the state’s pension system—and debunking the naysayers who claim that unfunded pension liabilities will obliterate municipal and state budgets.”

There’s no question that many investors will see returns approaching or even exceeding double-digit levels for the recently completed fiscal year, as the stock market has done exceedingly well in recent months. A pension crisis? As police officers often say at the scene of an accident, “Keep moving, folks. Nothing to see here.”

Californians need to temper the glowing statements and shrug off the efforts to keep us from looking too closely at the wreckage. Of course, impressive stock-market returns are a good thing that reduce the amount of taxpayer-backed pension obligations. But one good year doesn’t fix a problem that has been two decades in the making. For perspective, CalPERS’ returns for the previous two fiscal years were 0.6 percent and 2.4 percent respectively.

It could take decades to make up not only for past years of poor stock-market performance, but for the massive and relentless retroactive pension increases that state and municipal governments have been granting their workers since 1999.

“CalPERS’ funded ratio 20 years ago was 111 percent,” explained Stanford lecturer David Crane, who was Republican Gov. Arnold Schwarzenegger’s pension adviser. He notes that “despite a wonderful 6.7 percent annual return for 20 years, CalPERS’ funded ratio fell 48 percentage points… because pension liabilities compound at high rates.”

Crane was responding to a Sacramento Bee op-ed by a union president, who recently compared investment returns to the state’s drought: “The funded ratio of pension funds has risen and fallen like the levels at Lake Shasta.” The union official, Yvonne Walker of the Service Employees International Union Local 1000, has gotten an early start on the kind of argumentation we should expect. She blasts pension reformers’ “doomsday predictions.” Just like the drought, low returns won’t go on forever.

Indeed, private 401(k) retirement plans and public “defined benefit” plans both are dependent on investment returns, but in significantly different ways. In a 401(k) plan, the employee contributes a set amount of money to the account, to which some employers offer full or partial matches. If the market soars, the employee’s nest egg grows. If it falls, so does the account balance. There is no unfunded liability because the employee isn’t promised any specified amount of retirement income.

In the public sector, employees are guaranteed an annual benefit based on a formula. California police and fire officials, for instance, typically receive 90 percent or more of their final years’ pay until they and their spouse pass away. Nothing short of a municipal bankruptcy can legally reduce what they receive. The pension funds invest the dollars contributed by the agency and employees in the stock market. Even if the stock-market does poorly and the liabilities rise, the retirement pay stays the same.

That’s why CalPERS and other union-controlled pension funds have a vested interest in celebrating up years and downplaying bad years. Good years let them hide the amount of taxpayer-backed debt that’s accumulated. These pension funds also predict unrealistically high rates of return far into the future, which masks the size of the problem and reduces efforts to lower pension benefits.

But there is a steep cost to this approach. When public agencies spend more on pensions, they must cut services or raise taxes. Most are savvy enough to pitch the tax hikes as being for “public safety” or “transportation,” rather admit they are needed to pay for pensions. “Deceptively-hidden pension liabilities are already ravaging education and other public services and already causing tax, tuition and fee hikes,” Crane explained.

This is a national problem, although it hits California hardest because of the state’s overly generous pension system. A recent national study by the well-respected Hoover Institution at Stanford University found that “pension promises are consuming state and local budgets.”

The study says pension funds hide their costs through their investment assumptions: “What is in fact going on is that the governments are borrowing from workers and promising to repay that debt when they retire, but the accounting standards allow the bulk of this debt to go unreported through the assumption of high rates of return.”

There are a few good reasons for doom saying.

Even a year of good returns will do little to correct the vast level of pension underfunding. After this year’s returns, “the nation’s largest public pension system will still be seriously underfunded,” Ed Mendel reported in a recent Calpensions article. CalPERS is now only 65 percent funded and “is worried about a downturn that might drop funding below 50 percent, a red line actuaries think makes recovery very difficult.”

Pension spending continues to consume local and state budgets and is leading to cutbacks. In a recent CityWatch LA article, the California Policy Center’s David Schwartzman detailed governmental cutbacks in California cities tied to growing pension costs. For instance, Santa Barbara County laid off 70 employees and remains unable to fund $546 million in infrastructure improvements. In a July 8 article, Crane detailed the woes of California’s public school systems, which are struggling even during “an economic recovery and after a large tax increase.” He pins the blame on “exploding spending on pension and retiree health-care obligations.”

It’s unrealistic to bank on this year’s stock-market surge to be followed by additional surges. During his budget announcements each year, Gov. Jerry Brown (D) always features a chart showing that, since the turn of the millennium, the years with budget deficits outnumber those with surpluses. Brown’s points deal with general-fund budgets rather than pensions, but the point is similar. It’s more realistic to expect downturns than unending boom years.

Indeed, the Pensions & Investments article about the latest returns is aptly headlined, “Strong returns nice, but aren’t expected to last.” Ed Ring’s May 2016 California Policy Center analysis concluded that public pension funds “will be hit much harder in a downturn than private pension funds” because they “are not subject to the same rules that private pension funds have to adhere to.”

Because unions continue to control the state Capitol and many local governments, we will see a continued ratcheting of compensation levels. Here’s one small example from the VoiceofOC, which reported this month that the Santa Ana City Council just hiked the pay for 477 police employees “amid staff projections of major funding shortfalls.” Median police compensation there is now above $213,000, according to the news site. As we’ve seen many times before, good fiscal news typically leads unions to lobby for even higher pay and benefit levels.

By all means, let’s toast the favorable stock-market returns. But a more reasonable press release would suggest that despite those returns, the pension crisis continues to be as pressing as ever. Let’s not be misled by those with a vested interest in downplaying the problem.

Potential profits could’ve been used for government services

By David Crane | Governor Jerry Brown and the California Legislature have approved a scheme under which a special state fund filled with citizen-paid fees will lend money to the state General Fund, which in turn will contribute the proceeds to a state pension fund that in turn will invest in stocks in the hope of generating profits to help reduce pension deficits. In doing so, Brown and the legislature haven’t disclosed to citizens that the same profits, if earned, could’ve been used for more citizen services. Here’s how:

Brown’s scheme transfers $6 billion from the Surplus Money Investment Fund, which houses citizen-paid fees (eg, gas taxes, motor vehicle fees) until those fees are needed for government services such as road repair, etc. Brown says SMIF has more cash than it can use until 2030. Because current law limits SMIF from investing in anything other than short-term notes, he proposed that SMIF lend $6 billion at short term floating rates to the General Fund, which will contribute the proceeds to a state pension fund (CalPERS) that will invest for the longer term and use the hoped-for difference to reduce state spending on pension deficits.

Of course, another alternative would be to amend the statute that now limits SMIF’s investment options to allow SMIF to invest that cash on a longer term basis and generate those profits for itself. Brown expects his scheme to generate $11 billion in profits. If so, that’s an extra $11 billion that citizens could’ve added to funds to be used for road repair, etc.

Instead, Brown and the legislature have chosen to skim profits from citizens in order to pay past credit card charges; ie, to pay financing costs relating to past employee services that were charged to the future. Brown’s scheme also covers up past wealth transfers to employees. That wealth transfer occurs when “Normal Costs”—the only pension costs shared by state employees, as explained here and here—are artificially depressed by public pension fund boards setting artificially high investment return assumptions. For example, a decade ago in 2007 CalPERS used an 8 percent investment return assumption for setting Normal Costs. In contrast, the defined benefit plan at Berkshire Hathaway employed a materially-lower (6.9 percent) investment return assumption (see page 44 here). CalPERS’s use of the artificially higher rate reduced Normal Costs well below those of Berkshire’s—and also produced big pension deficits for citizens when, not surprisingly, actual investment returns fell well short of the inflated assumed rate. Now, Brown wants to skim profits from the investment of other citizen-funded monies to help address the deficits caused by insufficient Normal Costs. Citizens should feel battered.

Pension costs were relatively easy to address a decade ago. All that was necessary was a reasonable investment return assumption for setting Normal Costs. But state officials chose otherwise, leading to large and expensive pension debt that, as explained here, will continue growing fast. At this stage, the state should be seeking a reduction in pension debt, just as an indebted individual should seek to reduce credit card debt. One way to achieve that would’ve been for Brown and the legislature to tender an offer to employees to relinquish expensive future pension benefits in exchange for cash (or a market-rate note from the General Fund that tenderers could sell for cash). Just as a bank gives up expensive future interest earnings when credit card debt is paid off, employees should give up expensive future interest earnings when the state pays off pension debt. Instead Brown and the legislature have chosen a path that covers up past wealth transfers, allows the employees who benefited from those wealth transfers to keep earning expensive interest, and skims potential profits from citizens in order to fund that expensive interest.

Worse, there is no guarantee the loan will be paid back (the due date is on or before June 30, 2030; see the draft bill here). To understand how that might happen, try this thought experiment: How are a governor and legislature likely to act in 2030 when the terms of the loan require $6 billion to be transferred out of the General Fund to a special fund under their control for nothing in exchange? As a further thought experiment, just try to imagine Jerry Brown and the legislature transferring $6 billion this year from the General Fund to a special fund under their control in repayment of a borrowing drawn from a special fund long ago. What are the chances they would defer that repayment? Indeed, even quarterly interest payments are at risk to being skipped, especially in tough budget years. After all, the special fund is under the control of a governor and legislature who generally get credit for what they do with the General Fund, not with special funds. And if you’re thinking the designated source of loan repayment—a taxpayer-funded account established by Proposition 2 to accelerate payments on certain state debts— will make the payments, think again. That designation was just a fig leaf given that existing liabilities eligible for repayment by Prop 2 already dwarf the size of that fund.

Though Jerry Brown has not used his recent two terms in office to address core fiscal issues, until now he has generally avoided budget gimmicks. This time is different.

A letter sent today by David Crane:

Dear Legislators,

In my essay the other day I provided an alternative to Governor Brown’s pension loan — actually pay down pension debt.

You could do that by offering to redeem future pension payments for cash today. Provided the amount you pay is no greater than the present value of those future pension payments using the discount rate CalPERS uses to present value those payments, then you would actually pay off debt. If you wanted to save the citizens you serve even more money, you could start by offering less than present value.

Ideally such a pay-down would not be paid for with borrowed funds but if you insist on borrowing, then at least swap the floating rate loan from the special fund into a fixed rate loan so you actually know your cost and don’t subject citizens to floating rate loan risk. Together with the redemption outlined above, a fixed rate would lock in savings equal to the difference between the loan rate and the discount rate.

You should understand that the path proposed by Governor Brown and embraced by Treasurer Chiang and Senator Moorlach–a path you are about to embrace–is no different than the path mortgage lenders induced borrowers to take before 2008: i.e., a “teaser” low interest floating rate loan the proceeds of which are invested in assets (houses in that case) expected to grow at a higher rate and earn big profits for borrowers. Just see the stunning language from Brown’s budget below. That language goes beyond representations made by mortgage brokers and is eerily similar to assertions made by the state when it enacted SB 400 in 1999 (eg, “will not cost a dime”).

Public officials should not lead citizens down similar paths. You should actually pay down pension debt or you should not proceed with the current proposal.

David Crane

From page 7 of Governor Brown’s May Revision: “The May Revision proposes a $6 billion supplemental payment to CalPERS through a loan from the Surplus Money Investment Fund. This payment is expected to earn a 7 percent return from CalPERS, compared to the less than 1 percent currently earned from the fund. Over the next two decades, this supplemental payment will save an estimated $11 billion . . ..”