California Counties Ill-Prepared for a Recession; Public Agencies Need to Shape Up Before Too Late

On October 5th, in the Sacramento Bee, Guv Newsom announced he is putting together the 2020-21 State budget, to be made public in January.  He noted that the budget will be based on California being in a recession.  We know on 1/1/20, thanks to AB 5, tens of thousands, if not hundreds of thousands will lose their jobs and hundreds of thousands will be forced to join a union if they want to work.

“Between already-accrued pension benefits and CalPERS’s efforts to reduce unfunded liabilities, pension costs represent an increasing share of the annual budgets for many public agencies, crowding out discretionary spending and reducing the funds available for public services.

Managing these increasing costs is a difficult task. CalPERS pension benefits for all participating agencies are governed by the Public Employees’ Retirement Law (“PERL”) and by PEPRA, which places limits on agencies’ ability to reduce costs. Constitutional principles relating to vested rights make it difficult to make changes to benefits due to existing retirees. In addition, public employers contemplating changes to retirement benefits must ensure they notify and bargain with employees’ labor organizations to the extent required by the Meyers-Milias-Brown Act (“MMBA”). Understandably, public employees and employee organizations are often very hesitant about changes that could potentially reduce their own benefits.

There are solutions—but the unions will not allowed the Democrats running the State to save the pension systems.  A recession is happening in California, caused by government policy.  Local communities will feel the brunt of this, since they will be forced to cut public safety, libraries, road repair and more.  Angry yet?

California Counties Ill-Prepared for a Recession; Public Agencies Need to Shape Up Before Too Late

By Che I. Johnson and Lars. T Reed,    11/7/19 

In 2011, in a report that led to the enactment of the California Public Employee Pension Reform Act (“PEPRA”), the Little Hoover Commission gave a dire warning: 

California’s pension plans are dangerously underfunded, the result of overly generous benefit promises, wishful thinking and an unwillingness to plan prudently. Unless aggressive reforms are implemented now, the problem will get far worse, forcing counties and cities to severely reduce services and lay off employees to meet pension obligations.

This warning came after the Great Recession reduced the value of the CalPERS fund by 24 percent in a single fiscal year, leaving CalPERS 61 percent funded.

Today, after nearly a decade of market growth and increased pension contributions by both employees and employers, the situation is not fundamentally different. Despite the CalPERS fund more than doubling in size, CalPERS is still only about 70 percent funded. With fears of another recession looming, public agencies need to plan ahead and consider how CalPERS’s unfunded liabilities will affect them.

Although CalPERS has taken steps to reduce its unfunded liability, much of the burden fell on employers. For example, CalPERS changed actuarial policies to shorten the period in which employers pay their unfunded liability, trading higher up-front costs for long-term savings. CalPERS has also reduced its “discount rate” – its assumed investment returns – from 7.5 percent to 7 percent, meaning that agencies will have to pay higher contributions to pay for a given benefit. However, CalPERS’s own financial investment advisor has estimated that expected returns are closer to 6 percent, and if investment returns do not meet the 7 percent target, CalPERS is likely to increase contribution rates even further to make up for the shortfall. 

Between already-accrued pension benefits and CalPERS’s efforts to reduce unfunded liabilities, pension costs represent an increasing share of the annual budgets for many public agencies, crowding out discretionary spending and reducing the funds available for public services.

Managing these increasing costs is a difficult task. CalPERS pension benefits for all participating agencies are governed by the Public Employees’ Retirement Law (“PERL”) and by PEPRA, which places limits on agencies’ ability to reduce costs. Constitutional principles relating to vested rights make it difficult to make changes to benefits due to existing retirees. In addition, public employers contemplating changes to retirement benefits must ensure they notify and bargain with employees’ labor organizations to the extent required by the Meyers-Milias-Brown Act (“MMBA”). Understandably, public employees and employee organizations are often very hesitant about changes that could potentially reduce their own benefits.

In the past, one available tool was to negotiate lower benefits for future hires, while preserving benefits for existing employees and thus avoiding any impact on vested rights. However, this is no longer possible under PEPRA. PEPRA itself did impose a lower tier of benefits for “new members” (generally, those who first became CalPERS members in or after 2013). But the law also requires that all “classic members”, including lateral hires from other agencies, must receive the same benefits as if they had been hired in December 2012. Thus, in most agencies, reducing future benefits is no longer an option.

With all of these restrictions, trying to reduce increasing pension costs may seem like an impossible task. However, if agencies do not take steps to manage pension liabilities the problem will only compound over time, potentially leading to paycuts, layoffs, or even bankruptcy. Luckily, with a good understanding of the law and strong leadership agencies still have options available.

Cost sharing – Have employees shoulder more of the burden

Some provisions of PEPRA have helped reduce ongoing pension costs for employers by requiring employers to help fund their own future benefits. The law eliminated employer-paid member contributions for new members, and required that these employee pay at least 50 percent of the actuarial normal cost. For Classic members, agencies can still make the same reform by reducing or eliminating EPMC, in order to have employees bear the full cost of their own contributions. For both classic and new members, Government Code section 20516 allows employers and employees to agree to have employees pay a portion of the employer’s pension contributions. In addition, after negotiation through to impasse, Government Code section 20516.5 allows employers to impose cost sharing on classic members up to certain limits.

When negotiating cost sharing, agencies should carefully calculate the cost of anything given in return. For example, employee groups may ask for a salary increase that matches the amount of the cost share; this is not cost neutral because the salary increase will also result in other costs, such as increased CalPERS contributions and overtime costs. For an exchange to be cost neutral, the cost share amount will need to account for both its direct costs and these additional “roll up” costs.

Reducing reportable compensation

Another option is to negotiate changes to employees’ compensation and benefits to reduce the amount that is reportable to CalPERS (or “PERSable”). For example: a pay raise would increase PERSable compensation and therefore also increase future pension liability and ongoing pension contributions; instead, an agency could provide increased health benefits or paid time off.  Employers can also renegotiate specialty pays so that they do not match CalPERS’s requirements and therefore become non-reportable. For example, when a compensation item combines the requirements of two or more recognized special pays (such as longevity or performance bonuses), the result is a non-reportable “hybrid” pay. Similarly, CalPERS has indicated that lump sum payments are not PERSable when the employees also receive a general salary increase that year. And for new members, several forms of pay such as uniform allowance and one-time payments are not reportable under any circumstances.

Retiree medical benefits reform

Many agencies can potentially achieve significant savings by restructuring health benefit costs for current and future retirees, such as by moving retirees to more affordable plans or reducing the agency’s contributions. But agencies should be aware of legal limitations: for employers that provide healthcare benefits through CalPERS, statutory provisions set minimum limits for employer contributions. Employers should also analyze whether employees and retirees have vested rights that would impose constitutional protections on retirement benefits in their current form. Public agencies considering this option should consult with trusted legal counsel.

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Che I. Johnson is a Partner in Liebert Cassidy Whitmore’s Los Angeles office and is experienced in all aspects of employment and labor law. He regularly advises agencies on employee retirement plans. His can be reached at cjohnson@lcwlegal.com or 559.256.7805.

Lars T. Reed is an Associate in the Sacramento office of Liebert Cassidy Whitmore where he provides counsel and representation to clients on matters pertaining to employment law, labor relations, and litigation. His can be reached at lreed@lcwlegal.com or at 916-584-7011.

About Stephen Frank

Stephen Frank is the publisher and editor of California Political News and Views. He speaks all over California and appears as a guest on several radio shows each week. He has also served as a guest host on radio talk shows. He is a fulltime political consultant.