Rising California Pensions Costs Major Concern for Credit Rating Agencies

CalSTRS1A new Public Policy Institute of California poll shows the number of state residents worried about the cost of government pensions is at a 14-year low. In recent remarks to the Commonwealth Club in San Francisco, new state Superintendent of Public Instruction Tony Thurmond rejected the idea that pension costs were generally a major problem for school districts around the state.

But a recent comprehensive review by the Bond Buyer painted a starkly different picture. Based on interviews with officials in credit-rating agencies and the state’s Fiscal Crisis Management Action Team (FCMAT), as well as reviews of financial records from large school districts across the state, it forecast a wave of state takeovers of districts under the provisions of a 1991 state law that provides emergency loans to districts that can’t pay bills. But the loans come with the condition that district superintendents and school boards lose considerable autonomy over their budgets, which must have as a first priority repaying the loan to the state.

Nine districts have taken out such loans since 1991, and the Sacramento City Unified School District could become the 10th this fall when it is expected to run out of dwindling cash reserves.

A Fitch Ratings analysts told the Bond Buyer that about 50 of the 124 school districts it tracks have such low reserves that if an economic slowdown froze or reduced state revenue, those districts could quickly lose their capacity to pay bills. The same problems seen by Fitch in the larger districts that it monitors are likely to be seen in the 1,000-plus smaller districts it doesn’t track.

Low birth rate hurts enrollment

Since California’s overall population keeps going up, that’s obscured a key complication in school finances: The fact that school enrollment in much of the state is in the middle of a broad, long-term decline driven by changing demographics and birthrates that in 2017 hit an all-time low for the Golden State. FCMAT CEO Michael Fine estimates that 65 percent of the state’s 1,200 districts have fewer students than they used to. Perhaps the most dramatic decline is in Inglewood Unified, where present enrollment is 8,000 – about 40 percent of what it was in 2004.

Because state funding is based on the Average Daily Attendance formula, the enrollment declines can hammer districts even in a decade in which state funding for education has increased by more than 70 percent. That’s because many school districts don’t reduce their staffs by an amount equal to the lost enrollment. A FCMAT report on Oakland Unified issued last May called this a key factor in the financial strain faced by the district.

Another issue is that retirement benefits in some districts don’t just include pensions from the California State Teachers’ Retirement System. Some districts, including Los Angeles Unified and Sacramento City, offer generous health insurance to retirees for as long as they live.

S&P rating service downgraded LAUSD’s bonds last month. Fitch downgraded some of Sacramento City’s bonds in February, and further downgrades seem certain.

CalSTRS needs booming market

Officials with CalSTRS remain optimistic that healthy investment returns can reduce CalSTRS’ present unfunded liabilities of about $100 billion. Boom markets on Wall Street have at times allowed CalSTRS to keep mandatory pension contributions relatively flat for years at a time.

But the 2007 recession hammered CalSTRS, forcing the Legislature and Gov. Jerry Brown to pass a bailout measure in 2014 that will roughly double annual contributions from districts, the state and teachers by July 2020, when its final increase is phased in.

But hopes that profitable investments will be a big help in reducing liabilities aren’t coming to pass. The Sacramento Bee reported recently that CalSTRS only had a 1.62 percent return on its portfolio for the first eight months of fiscal 2018-19 and was not expected to meet its target of a 7 percent annual return.

This article was originally published by CalWatchdog.com

A tale of two cities and blocked pension reforms

san diegoA San Diego city attorney urged an appeals court last week to order talks with unions on repaying 4,000 employees for pensions illegally replaced by 401(k)-style plans under an initiative, a cost some estimate could reach $100 million.

If the talks result in agreement, the city attorney suggested the pact could go back to voters for approval. Though not mentioned by the attorney, that’s what happened to another cost-cutting pension reform in San Jose also approved by two-thirds of voters in June 2012.

The two reforms had different cost-cutting curbs. But both had trouble in the courts. The San Diego reform was overturned. The San Jose reform lost a key provision. Both also were found by a powerful state labor board to have failed to bargain with unions in good faith.

In the end, San Diego seems likely to have increased pension costs, not cut them. San Jose got some cuts in pension costs, but not the big one. The winner, for better or worse, seems to be the status quo in pension protection.

Last August the state Supreme Court ruled that former San Diego Mayor Jerry Sanders, the city’s designated bargaining agent, violated state labor law when he did not bargain or “meet and confer” with unions before pushing the reform initiative.

“He consistently invoked his position as mayor and used city resources and employees to draft, promote, and support the Initiative,” the ruling said. “The city’s assertion that his support was merely that of a private citizen does not withstand objective scrutiny.”

The Supreme Court ordered a three-justice appeals court panel, which upheld the San Diego reform two years ago, to “address the appropriate judicial remedy.” The appellate court had not done so previously because of its ruling of no violation.

At the hearing last week, Travis Phelps, a city attorney, urged the court to order city bargaining with the unions on the reform initiative and any repayment for losses, possibly resulting in an alternative to the reform initiative that could be placed before voters.

An attorney for four city unions, Ann Smith, urged the court to adopt the state Public Employment Relations Board traditional order to “make employees whole for any losses” with an interest rate of 7 percent, the pension fund earnings forecast at the time.

“In every instance the status quo ante must be restored in full or otherwise employers are encouraged to violate the act” that requires bargaining, Smith said, because they could keep some of the gain.

Estimates of complying with the board order have ranged from $20 million to $100 million, depending on a variety of factors, the San Diego Union-Tribune newspaper reported last week.

Smith said the court had not received a compelling argument that the labor board abused its discretion in ordering a make whole remedy. She said the state Supreme Court ruling noted that labor board rulings have received high court deference in the past

In a suggestion apparently not mentioned in the briefs, Smith said the make whole remedy could be applied to city employees represented by unions, but not to managers and other city employees who are not members of unions.

The Proposition B pension reform initiative approved by voters in 2012 has not been invalidated. New city hires are still receiving a 401(k)-style retirement plan rather than a pension.

The state labor board said it lacks the authority to invalidate the initiative. What the state Supreme Court said about invalidating the initiative resulted in a clash of metaphors at the hearing.

Smith said the Supreme Court did not tell the appeals court to invalidate Proposition B but “they dropped all the bread crumbs on that trail.” Justice Richard Huffman said he was “long past reading Supreme Court tea leaves.”

The city attorney, Phelps, argued that a voter-approved initiative can only be overturned through a separate “quo warranto” process filed in superior court. He said citizen backers of the initiative, barred from labor board proceedings, presumably could testify.

Phelps said problems would be created if the appeals court, as the union attorney urged, made a straight invalidation of the initiative without modification or ordering bargaining to seek a solution.

About 4,000 employees hired since the reform have individual vested rights to the matching employer contributions to their 401(k)-style retirement plan, 9.2 percent of pay for miscellaneous employees and 11 percent of pay for firefighters and lifeguards.

“You can’t simply take that away,” Phelps said.

Retroactively enrolling employees in the city pension plan who have been in the 401(k)-style plan would require approval of the IRS, he said, which is not a given. He said tax exemption for the city and its employees could be at risk.

Smith said a quo warranto hearing is not needed because of the Supreme Court ruling of a procedural error and that hearing from the citizen proponents doesn’t matter at this point, drawing a rebuke from Justice Huffman.

“The notion that we can invalidate their measure, based on PERB’s facts without the participation of the proponents, strikes me as not the kind of process I’m used to,” Huffman said.

Smith said the state Supreme Court has reiterated that local initiative rights are not absolute. They must be “harmonized” with statewide rights, she said, which proponents had the opportunity to do before and after the initiative passed.

An attorney for the citizen proponents of the initiative, Alena Shamos, said a make whole remedy would gut the intent of the initiative, a response to the “crisis” of high pension costs, and would be the same as invalidation.

“We would agree with the city that meet and confer would be the proper remedy,” Shamos said, which could result in fines and penalties for the city.

A PERB attorney, Joseph Eckhart, said allowing initiative rights to override state bargaining law would undermine the case as much as if there had been no violation. He said any remaining dispute after city and union bargaining would go back to the labor board.

The San Diego reform excluded police and was limited to new hires, avoiding the San Jose reform’s clash with police and the “California Rule,” a series of state court rulings that prevents cuts in the pension offered at hire unless offset with a new benefit.

A key part of the San Jose measure pushed by former Mayor Chuck Reed gave current employees an option: pay more for a pension or begin earning a smaller pension in the future.

The option for current employees who have vested rights, unlike new hires, was overturned by a superior court judge citing the California Rule. But much of the measure placed on the ballot by the city council was allowed.

Reed and other reformers thought the option for current workers might get a long-sought review of the California Rule by the state supreme court. But the superior court ruling was not appealed as the reform battle continued for three more years.

In November 2014 Councilman Sam Liccardo was elected mayor, defeating a union-backed candidate reportedly supported by an $800,000 campaign. A day later two PERB rulings said the reform measure was not bargained in good faith.

Liccardo announced a settlement in 2015 that dropped an appeal of the superior court ruling and avoided a long and costly battle over nine union lawsuits. Reed endorsed the settlement expected to save the city $3 billion over 30 years and aid police retention.

In March 2016 the city used a quo warranto procedure to repeal Measure B in superior court, allowing a more generous pension plan to attract police to a long-depleted force working mandatory overtime.

In November of that year 61 percent of San Jose voters approved Measure F, a replacement for the original reform backed by a coalition of labor and business leaders, including Liccardo and police and firefighter union officials.

Supporters said Measure F would lock in pension savings and end years of bitter union-management fighting and litigation. Opponents said it was a capitulation to unions that allowed retroactive pension increases and other cost increases.

As San Diego awaits the appeals court ruling on a Proposition B remedy, the U.S. Supreme Court announced today that it will not review the city’s appeal based on the state Supreme Court ignoring Sanders’ First Amendment free speech rights.

Click here for video of the appeals court hearing, March 11 beginning at 2:30.

Reporter Ed Mendel covered the Capitol in Sacramento for nearly three decades, most recently for the San Diego Union-Tribune.

This article was originally published by CalPensions.com

Latest Pension Ruling Likely To Create Future Uncertainty

CourtFor the second time in two years, the California Supreme Court has released a ruling on a large state issue that analysts say creates new uncertainty going forward.

Last week, the court issued its long-awaited decision in a court case involving a Sacramento local firefighters union that alleged a provision of the 2012 pension reform measure approved by the Legislature and signed by then-Gov. Jerry Brown was illegal under the “California Rule.” That’s the legal concept stemming from a 1955 state Supreme Court ruling that holds the terms of a public employee’s pension benefit cannot be reduced for years not yet worked, only kept the same or increased.

Cal Fire Local 2881 said that the pension reform’s ban on “air time” – the purchase of service credits to enhance pensions – violated the California Rule. But a unanimous state Supreme Court said “air time” was not a comprehensively bargained or legislatively approved vested right.

Yet in the lead opinion, Chief Justice Tani Cantil-Sakauye (pictured) explicitly said she was not taking a position on the California Rule question of whether pension terms could be changed going forward for years not worked.

This mixed message produced media confusion. Some news bulletins declared the justices had approved allowing a rollback of local benefits. Others suggested the California Rule had dodged a bullet.

Was ‘California Rule’ weakened or untouched?

Interest groups were similarly split.

Officials with the League of California Cities saw the court’s willingness to change the terms of pensions on a relatively minor issue as a sign it was open to a significant weakening of the California Rule. The league and many like groups hope for a state Supreme Court ruling that echoes a lower court’s ruling that pensions are not “immutable.” They were heartened by Cantil-Sakauye specifically noting the state had raised the retirement age from 67 to 70 for current as well as prospective employees.

But the Californians for Retirement Security, which represents 1.6 million public employees and former public employees, declared victory after noting that Cantil-Sakauye had specifically said “air time” was changeable because it was not a vested right – unlike basic pension formulas basing retirement checks on years worked times a percent of late-career salary.

The group and others also cited a concurring opinion written by Justice Leondra Kruger and joined by Justice Goodwin Liu that held that government employers could not “withdraw” from the pension terms established upon initial employment by “an implied unilateral contract.”

The state Supreme Court is expected to eventually take up at least two more cases involving union objections to the 2012 pension reform, so the sanctity and extent of the California Rule is likely to remain in the news. In his final year in office, Gov. Jerry Brown repeatedly urged the court to give governments the option to change future pension terms as pension costs have crowded out local, county and school programs and services. Brown’s office defended the 2012 reform law before the high court because of concern that state Attorney General Xavier Becerra was not eager to defend it.

Like 2017 case, ruling seen as murky, not clarifying

But in the meantime, last week’s ruling seems as murky as the court’s decision in the 2017 California Cannabis Coalition v. City of Upland case. Previously, Proposition 218, approved by voters in 1996, had been understood to require that any tax whose revenue would go to a special purpose – building a sports arena, adding libraries, etc. – had to be approved by a two-thirds vote.

Upending decades of precedent, the state Supreme Court held in a 5-2 decision that the two-thirds threshold applied only to ballot measures initiated by local governments. Because they were not local government measures, those qualified by citizen initiatives only needed simple majority support to be enacted.

In dissent, Justice Kruger took square aim at the idea that this interpretation was what voters expected in 1996 when they made it harder for local governments to raise taxes.

Kruger wrote, “A tax passed by voter initiative, no less than a tax passed by vote of the city council, is a tax of the local government, to be collected by the local government, to raise revenue for the local government. None of this could have been lost on the electorate that, also by initiative, amended the California Constitution to set ground rules for voter approval of local taxes.”

This article was originally published by CalWatchdog.com

What Recent Pension Ruling Means for California’s Taxpayers

pension-2Last week, the California Supreme Court issued a ruling in Cal Fire Local 2881 v. CalPERS, a case involving public employee pensions. For taxpayers, the decision was a mixed bag. On the plus side, the court refused to find a contractual right to retain an option to purchase “air time,” a perk that allowed employees with at least five years of service to purchase up to five years of additional credits before they retire. Under this plan, a 20-year employee could receive a pension based on 25 years of contributions.

On the negative side, the high court left intact, for now, the so-called California Rule, which has been interpreted as an impediment to government entities seeking to reduce their pension costs. The rule, unique to California, provides that no pension benefit provided to public employees via a statute can be withdrawn without replacement of a “comparable” benefit, even as deferred compensation for services not yet provided.

The unanimous 54-page opinion by the Supreme Court resulted in a wide variance of headlines and social media posts. The Associated Press read “California’s Supreme Court upholds pension rollback.” Ironically, a conservative reform group sharply criticized the decision for failing to repeal the California rule outright while another conservative policy organization called it a “victory for taxpayers.”

So what was it?

To read the entire column, please click here.

Pension Funds, Meet the “Super Bubble”

Earlier this month, outgoing California Governor Jerry Brown predicted “fiscal oblivion” if California’s state and local agencies are not granted more flexibility to modify pension benefits. As if to help Governor Brown make his point, U.S. stock indexes took an obliging plunge. The Dow Jones average cratered in December, dropping nearly 16 percent in three weeks, from 25,826 on December 3rd to a low of 21,792 on December 24th. And whither hence? Nobody knows.

If history and trends are any indication, however, “up” is unlikely. Depicted on the chart below is the performance of the Dow Jones Index from 1995, when the markets began first showing signs of “irrational exuberance,” to the extremely exuberant present day. Clearly shown are the past two bubbles, the internet bubble of 2000, the housing bubble of 2007, and what we may call the “super bubble” or “everything bubble” of 2018.

Dow Jones Stock Index – 1995-2018 

It doesn’t take an economist to notice a pattern here. The Dow Jones Index, which tracks closely with all publicly traded equities in the U.S., more than doubled in the four year heady run-up to its January 2000 peak, than went into decline for nearly four years, before doubling again between 2004 and 2007. Then when the housing bubble popped, the Dow went off a cliff, dropping to half its 2007 peak in little over a year. In the ten years since 2009, the Dow has exploded again, tripling to a high of 26,743 in September 2018. What now? Visually, at least, another correction is past-due.

There are all kinds of economic reasons why what is visually indicated on the above graph is exactly what’s going to happen. At best, we may hope for stocks to merely stop going up, which is sort of what happened after the internet bubble popped. But what’s different this time?

One key difference is that this time, lowering interest rates is not an option. In January 2000 the Federal Funds rate was 5.5 percent. By June of 2003 it had dropped to 1.0 percent. When interest rates drop, stocks become relatively better investments than fixed rate investments. Lower interest rates also induce more people to borrow, creating liquidity, stimulating consumer spending, which helps corporate earnings which drives up stock prices. The cause and effect is reflected in the stock market history – by 2003, after lowering interest rates by 4.5%, the stock market finally began to recover.

In October 2006 the rate had risen to 5.25 percent. In September 2007, as home sales were starting to drop, it was lowered to 4.75 percent. When the housing bubble popped, and the stock market crashed, the Federal Reserve responded by steady lowering of the Federal Funds Rate. By December 2016 it had dropped to 0.25 percent, the lowest rate possible. What should be of concern, is that the rate today, 2.5 percent, is only half as high as it was during the past peaks. During the previous two bull markets, the Federal Reserve was able to bounce the rate up to around 5 percent before the bears came calling. This time, assuming we’ve hit the peak, only half that increase, to 2.5 percent, was achievable.

A consequence of low interest rates is more borrowing, which is a good thing if that borrowing stimulates economic growth that translates into investments in productivity. But borrowing has not been used to stimulate productive investments. Instead, much of the corporate borrowing over the past decade has been used to finance stock buy-backs. This is a dangerous strategy, causing short-term growth in earnings per share, but loading debt onto corporate balance sheets that will have to be refinanced at interest rates that are increasing, at the same time as investment in research and modernizing plant and equipment has been neglected.

In recent years, borrowing has also been an overused tool of government, starting with the federal government. Federal borrowing accelerated in mid-2008, and hasn’t slowed down since, climbing to over $21 trillion by the 3rd quarter of 2018. As interest rates rise, servicing this debt will become far more difficult. Meanwhile, all U.S. credit market debt – government, corporate, and consumer – has continued to increase. After dipping slightly to $54 trillion in the wake of the burst housing bubble, it was up to a new high of $68 trillion by the end of 2017.

When interest rates fall, not only is the stock market stimulated. Bonds make payments at fixed rates, so when the market rate drops, the price of these bonds increases, since they can be sold for whatever price will give the buyer the same return as the current market rate. Interest rate reductions also cause housing prices to rise, since when interest rates are low, people can afford bigger mortgages since they will be making lower monthly payments. The opposite is also true, which is unfortunate for investors. All else held equal, rising interest rates means lower prices for bonds and housing.

What does this mean for pension funds?

When the super bubble pops this time, all assets will drop in value. Everything pension funds are invested in, equities, bonds, and real estate, will all drop in value. Even if extraordinary measures are taken to stop the decline – such as the fed purchasing corporate bonds – there will be nowhere to run. Public sector pension funds have not prepared for this day of reckoning. CalPERS, for example, in its most recent financial statements was only 71% funded. That would be ok at the end of a bear market, but at the end of a bull market, that is a disaster waiting to happen.

As it is, using CalPERS as an example, government agencies are going to have to nearly double their annual payments. The primary reason for this increase appears to be so the participating agencies will eliminate their unfunded liability on a 20 year repayment schedule. To-date, agencies were making those repayments on a 30 year term, and using creative accounting to minimize the payment amounts in the early years. CalPERS does not appear to have lowered the amount they are expecting their investments to earn, and this is critical. Because while they have lowered their expected rate of return to “only” 7.0 percent, they have also quietly lowered their long-term assumed inflation rate. This means they are still relying on nearly the same real rate of return for their investments.

When the super bubble pops, the challenges facing pension funds will not be the only economic problem facing Americans. Unwinding the debt accumulated during a credit binge lasting decades will impact all sectors of the economy. The last thing the fragile finances of government agencies will need is even higher required contributions to the failing pension funds. Instead those running these pension systems need to try new approaches, including modifying benefit formulas, but also redirecting investments into local infrastructure projects – projects that not only create jobs, but address practical and urgent goals such as building resilient, upgraded backbones for supplying water, energy, and transportation.

In early 2019, the California Supreme Court is about to issue one of its most consequential rulings ever, in the case CalFire Local 2881 vs. CalPERSIt is possible this ruling will grant government agencies (and voters) more flexibility to modify pension benefits. Such an opportunity cannot come too soon, if fiscal oblivion is to be avoided when the super bubble finally pops.

How Local Governments Can Reform Pensions IF the “California Rule” is Overturned

pension-2In December of 2018, the California Supreme Court will hear arguments in what is generally referred to as the Cal Fire pension case. The ruling could potentially overturn what is commonly referred to as the “California Rule.” The current interpretation of the rule is that pension benefits, once increased, cannot be reduced for existing employees even for future years of service without the agency providing a benefit of equal value to the employee.

What reforms would become possible if the Supreme Court rules that changes for future years of service are not protected by the California Rule?

To demonstrate how this ruling could be a game changer and open the door to pension reform for nearly every city and county in California, this article uses the potential savings for various reform options for the County of Sonoma.

It should be noted that any changes to the pension system if there is a favorable ruling by the court would need to be made by the governing body of each agency and if they refuse to act, could also be made by the taxpayers through the voter initiative process.

Current Situation in Sonoma County

The pension system for Sonoma County employees was founded in 1945 and up until 1993 was a sustainable and affordable system that paid career employees 2% per year of service. This would mean, for example, that after a 35 year career a retiree would collect a pension equal to 70% of their final base salary. Sonoma County employees are also eligible to receive Social Security benefits. Over the first 48 years until 1993, the pension system had accrued $355 million in total pension liabilities (money owed to retirees and earned to date by current employees).

But then, due to a series of illegal pension increases back to the date people were hired in 1998, 2003, 2004 and 2006, pensions for employees with only 30 years of employment jumped (including “spiking”) to 96% of their gross pay. After the first increase, the liability had doubled from the 1993 $355 million amount to $793 million in 1999. The liability doubled again in 9 years and hit $1.9 billion in 2009. Last year, in 2017 the pension liability reached $3.34 billion, a staggering 941% growth over 24 years.

The Growth of Sonoma County’s Pension Liability
$=Billions

To pay off the soaring liability, Sonoma County issued pension obligation bonds in 1994, 2003 and 2010 totaling $597 million dollars of principal. Paying off the bonds with interest will cost taxpayers $1.2 billion on top of their normal pension contributions. Currently, the County owes $650 million in principal and interest on the bonds that will cost them an average of $43 million per year until 2030.

In addition, the County’s contribution to the pension system (including debt service on the pension obligation bonds) has grown from $8 million in 1998 to $117 million in 2017. In other words, we have a serious math problem on our hands. While tax revenues have been growing at 3% per year, pension and healthcare costs have grown by 19%. Something has to give. In Sonoma County we have two choices, do nothing and pay higher taxes for fewer services, or, if possible (depending on the outcome of the Supreme Court case), reform our pension system to make it more equitable for taxpayers and more secure for employees and retirees.

So far, money has been taken from our roads and infrastructure maintenance budgets and the County has borrowed $597 million to pay for pensions. Soon, more and more money is going to come from cuts to fire and police protection, and services for those to in need. The retroactive pension increases not properly funded have essentially created a debt generation engine that sticks our children and grandchildren with enormous debt for services received in the past.

The Pension Increases May Have Been Illegal

In 2012 responding to a complaint I filed, the Sonoma County Civil Grand Jury could not find any evidence that the County followed the law when pensions were increased. The California Government Code in Section 7507 requires that the public be notified of the future annual cost of the increase. However, records show that all of the retroactive pension increases were enacted without determining the future annual costs and the public was never notified. This is a serious issue since public notification is the only protection taxpayers have. In addition, documents uncovered by New Sonoma indicate that the agreement was for the General employees to pay 100% of the past and future cost of the increase and Safety employees to pay 50% of the cost. This requirement was never enforced by the Sonoma County Retirement Association as it should have, so the vast majority of the costs for the benefit increases have been illegally borne by the County’s taxpayers.

These same increases were enacted at the state and local level from 1999 to 2008 for almost every public agency throughout the state. Cursory investigations of other cities conducted by the California Policy Center and Civil Grand Jury’s in Marin and Sutter county found similar violations at every agency investigated. A lawsuit is currently under appeal that would void illegal increases back to the date they were enacted which would in Sonoma County’s case save taxpayers $1.2 billion over the years ahead. But even if this case fails, other reform options may be available soon as a result of a favorable supreme court ruling. Here they are:

1. Cap the Employer Contribution

A lot of problems could be fixed at the governance level if employees felt the impact of growing unfunded liabilities. As long as the current situation of the employer/taxpayer covering 100% of the unfunded liability and debt service on the bonds exists, the problem will continue to grow and reforms will be minimal because all actuarial losses fall on the taxpayer.

Capping the employer contribution at 15% of salary (still 5 times what private sector employers contribute to retirement funds for their employees) would cut pension costs in Sonoma County from $117 million to $55.4 million, a savings to the county of $61.6 million per year. And as pension costs increase over the years ahead, the employees will pay all the costs associated with the growth.

2. Split All Pension Costs 50/50 Between the County and Employees

Currently the employer contribution is 19% of payroll. The current pension bond debt service, all paid for by the employer, is 11.3% of payroll. The current employee contribution is 11.6% of payroll. Therefore Sonoma County’s total pension costs in 2017 were 42% of payroll.

Capping employer contributions at 50% of pension costs or 21% of payroll would save the county $50 million per year, a cost that would be borne by employees in additional pension contributions.

3. Provide an Opt Out for Employees to a 401k Plan

Instead of forcing employees to contribute 21% of their take-home pay to their pension, a 401k option could be created.

Existing employees could be provided with the option of moving the present value of their future pension benefit into a 401k account and opting out of the defined benefit pension system. Going forward, the County could provide them with a 10% of base salary 401k contribution which the employee could match for a 20% contribution. Then, if the employee wanted to turn their account balance into a defined benefit for life, they could purchase an annuity upon retirement using their 401k funds.

Studies show young people entering the workforce prefer the portability of a 401k plan because they don’t see themselves in the same career their entire lives. Defined benefit pension funds also punish folks who leave the system early and highly reward those that stay because they are back loaded by design.

A lot of folks might also choose this option because they may be worried about the soundness of their pension plan, which in Sonoma County’s case, they should be.

4. Improve Pension Board Governance

Require a majority of non pension fund members on the Sonoma County Employee Retirement Association (SCERA) board or move the servicing of the fund, if possible to a private entity because of the conflicts of interest that exist when board members are also part of the pension system.

5. Establish Greater Transparency

Establish a COIN Ordinance to require the County Supervisors to hire an outside negotiator during contract negotiations and to provide the public with the cost impact of any changes to the citizens ahead of approval.

6. Mandate Public/Private Pay Equity

Require the County to perform a prevailing wage study and offer new County hires salaries that are similar to what Sonoma County residents earn in the private sector for work requiring comparable education and skills.

7. Return Spending Authority to Voters 

Require voter approval of any pension obligation bonds, and require voter approval of any increases to pension formulas or increases to salaries in excess of inflation.

6. Eliminate Conflicts of Interest

Do not allow elected officials to be members of the pension system due to the obvious conflict of interest.

7. Improve Public Oversight

Create a permanent Citizens Advisory Committee on Pensions that would provide an annual study of the pension system and track the success of pension reform efforts and provide recommendations to the Board of Supervisors. All reports prepared by the committee will be posted on the Committee’s webpage on the County’s website. The committee would have the power to perform accounting and regulatory compliance audits of the Sonoma County Retirement Association, investigate any evidence of illegal acts, and recommend appropriate remedies to the Board of Supervisors. A description of any violations and any committee recommendations will be posted on the Committee’s webpage on the County’s website.

This article was originally published by the California Policy Center

*   *   *

Ken Churchill has over 40 years of business and financial management experience as founder, CEO and CFO of a solar energy company and environmental consulting firm. In 2012 after discovering the county illegally increased pensions without the required public notification of the cost he founded New Sonoma, and organization of financial experts and citizens to investigate the increase and inform the public. Information on New Sonoma and their findings and court case can be found at www.newsonoma.org.

Gov. Brown Will Defend Public Pension Reform Dec. 5

SACRAMENTO, CA - OCTOBER 27:  California Governor Jerry Brown announces his public employee pension reform plan October 27, 2011 at the State Capitol in Sacramento, California.  Gov. Brown proposed 12 major reforms for state and local pension systems that he claims would end abuses and reduce taypayer costs by billions of dollars.  (Photo by Max Whittaker/Getty Images)

As he requested, Gov. Brown will get a chance before leaving office to defend a public employee union challenge to his pension reform that some think could result in a ruling allowing pension cuts.

The state Supreme Court yesterday announced oral arguments scheduled Dec. 5 in Los Angeles on a firefighter appeal to allow employees to continue boosting their pensions by purchasing up to five years of “airtime,” credit for years in which they did no work.

If the court finds airtime is a vested right, the court could modify the “California rule” that prevents cuts in the pensions of current workers, limiting most cost-cutting reforms to new unvested hires, which can take decades to yield significant savings.

The airtime case, Cal Fire Local 2881 vs. CalPERS, one of five similar challenges to the pension reform, was fully briefed last January. Brown’s legal office replaced the state attorney general in the defense of the airtime ban.

“As the end of Governor Brown’s term in office draws closer, we respectfully urge the Court to calendar this matter for argument as soon as possible,” the governor’s legal affairs office said in a letter to the Supreme Court last July 6.

The Supreme Court said in September that Cal Fire oral arguments might be held as soon as November. The arguments on Dec. 5 are during the last regularly scheduled week of oral arguments before Gov.-elect Gavin Newsom is sworn in Jan. 7.

“This move was animated in large part by Governor Brown’s deep concern for the fiscal integrity and solvency of public pension systems throughout the state,” said the governor’s legal office letter in July, referring to taking over defense of the reform.

“It was the same concern that motivated him to help develop the Public Employees’ Pension Reform Act of 2013, and sign it into law,” said the letter.

Brown has left a seat vacant on the seven-member Supreme Court for a record 14 months. Former Supreme Court Justice Kathryn Werdegar gave notice in March last year that she would retire in August.

If no appointment is made before Dec. 5, a key vote on pension reform could come from one of the rotating appeals court justices brought up to hear more than 100 cases so far.

The six current members of the Supreme Court are evenly split between three appointees made by Brown, a Democrat, and three appointees made by former Republican governors.

“It’s not something I want to do too quickly,” Brown said in January, one of his few publicly reported remarks about the vacancy. “It’s very important now. I have appointed three. The fourth could be very decisive. So I want to understand how that decisivness should work.”

Among the speculation is that Brown may appoint an aide he wants to retain as long as possible, wanted a four-year delay in a retention election for the new election by waiting past the September deadline for the ballot this month, or may appoint his wife Anne Gust Brown.

The California rule has been cited as courts overturned several cost-cutting pension reforms approved by voters. For example, a Pacific Grove limit on payments to CalPERS in 2010 and a San Francisco ban on supplemental pension payments in 2011.

In 2012, a superior court overturned a key part of a San Jose measure approved by 69 percent of voters that would have cut the cost of pensions that current workers earn for future work, while protecting pension amounts already earned.

The plan pushed by former San Jose Mayor Chuck Reed, a Democrat, would have given current workers the option of paying more to continue earning the same pension, up to 16 percent of pay, or choosing a less costly pension that would pay less in retirement.

A superior court overturned the option citing the California rule, a series of state court decisions believed to mean the pension promised at hire becomes a “vested right,” protected by contract law, that can only be cut if offset by a comparable new benefit, erasing cost savings.

Reed, now on the board of the bipartisan Retirement Security Initiative pension reform group, said pensions have been losing ground. CalPERS had a debt or funded liability of $90 billion in 2012, when the Brown reform legislation was approved, and $138 billion in 2016.

He said five different lawyers have filed five friend-of-the court briefs outlining five different approaches to modifying the California rule. One of the questions in the Cal Fire case is whether the Supreme Court will rule on vested rights and the California rule.

The Supreme Court summary says the Cal Fire case presents two issues: 1) Was the option to purchase airtime a vested pension benefit (2) and if so, did the legislation ending airtime purchases violate the contracts clause of the state and federal constitutions?

If the court finds that airtime is not a vested benefit, the court might also decide there is no need to rule on whether the airtime ban violates the contracts clauses and the California rule.

“This is the California State Supreme Court and this is a real big issue, and I would be very surprised if they didn’t take the opportunity to be more expansive than narrow,” Reed, a lawyer, said yesterday. “But I’m only guessing.”

Gregg Adam, a Messing Adam & Jasmine attorney for Cal Fire, said “our client is excited that oral argument is scheduled,” and the case has been extensively briefed by the parties and friends of the court.

“A narrow ruling is certainly possible,” Adam said in an email. “The Governor argues additional retirement service credit is not the type of pension benefit that the California Rule protects. If the Court agrees with him, the opinion will be short.

“We hope the Court reaches the larger issue. The benefit was integral to employees’ retirement security. It also encouraged diversity and education in state service. So we think it falls squarely within the category of benefits protected by the California Rule.

“The California Supreme Court has led on this issue and, especially at this time, we’re going to encourage it to continue to do so.

“With respect to Alameda, the Court will determine when it is ready to resolve the issues in that case, which may or may not be affected by any ruling in Cal Fire.”

Alameda County Deputy Sheriff’s Assn. v. Alameda County Employees’ Retirement Assn. was consolidated with similar Contra Costa and Merced county cases challenging a part of the reform that prevents “spiking” by boosting the final pay on which pensions are based.

The Supreme Court designated the Alameda case as the lead for three other similar cases challenging parts of the governor’s reform. The governor’s office had no comment yesterday on the pension cases.

Reporter Ed Mendel covered the Capitol in Sacramento for nearly three decades, most recently for the San Diego Union-Tribune.

This article was originally published by Fox and Hounds Daily

More Than 100 Local Governments Pursue Tax Hikes to Meet Soaring Pension Bills

TaxesNine months after a League of California Cities report warned that pension costs were increasingly unsustainable, more than 100 local governments in the Golden State are asking voters for tax hikes on Nov. 6 – which Bond Buyer says is nearly double the record of 56 set in November 2016.

The Nov. 6 measures are on top of 36 city and county taxes that went before voters in the June 2018 primary.

Historically, local hikes in sales and hotel taxes are approved at least 60 percent of the time in California. They’re generally linked to a specific local need – not growing labor costs. With CalPERS’ bills to local governments on track to double from 2015 to 2025, such claims would seem dubious this election year.

Nevertheless – aware that voters likely would be cool to the idea of raising taxes to pay for pensions far more generous than those in the private sector – even now, many local elected leaders depict the hikes as necessary to pay for public safety or for fixing potholes and longer library hours.

Local officials assert hikes are about adding services

In the lead-up to the June primary, virtually the entire city leadership ranks in Chula Vista campaigned for a half-cent sales tax hike on the grounds that it was crucial to adding dozens of badly needed police officers and firefighters.

The tactic worked as Chula Vistans backed the increase. But city leaders’ claims of a coming public-safety hiring spree were impossible to square with the numbers from the city’s budget office. In April, it warned of “bleak” times ahead for San Diego County’s second-largest city, including an annual structural deficit that could reach $26.6 million by 2023 – with surging pension bills mostly to blame.

In Santa Ana, where voters are being asked to raise sales taxes by 1.5 percentage points on Nov. 6, the campaign for the tax hike rarely mentions pension costs.

But once again, a city bureaucrat framed the tax hike in more candid fashion.

“We’re not immune to the labor cost increases that are occurring throughout the state of California and throughout the country. We need to be able to provide additional services to the community. The question before the voters is what level of services do they want from their government?” Jorge Garcia, a top aide in the Santa Ana city manager’s office, told Bond Buyer.

Santa Ana’s pension bill is expected to go from $45.1 million in 2017-2018 to $81.2 million by 2022-2023 – an 80 percent increase.

‘The cause of this point-blank is CalPERS’

But some politicians have no patience with misleading narratives. “The cause of this point-blank is CalPERS and our pension fund,” Lodi Councilwoman JoAnne Mounce said in June when the Lodi City Council decided to put a half-cent sales tax on the Nov. 6 ballot.

As the League of California Cities reported in January, “With local pension costs outstripping revenue growth, many cites face difficult choices that will be compounded in the next recession. Under current law, cities have two choices – attempt to increase revenue or reduce services.”

The severity of the pension crisis is illustrated by the fact that it is sharply worsening in a period in which there is often seemingly good news on the fiscal front.

State revenue is expected to go up in 2018-19 for a 10th straight year.

County assessors report a 6.5 percent increase in property taxes this year. That’s triple the rate of inflation and comes even with Proposition 13 preventing increases of more than 2 percent on homes, businesses and other properties that didn’t change hands.

In July, CalPERS announced a second straight year of above-average earnings on its investment portfolio, which rose in value to $357 billion.

This prompted a news release from a top state union leader disputing talk of CalPERS’ poor health.

“While it’s important not to focus on one-year returns, these returns continue the long-term trend of CalPERS performing above or near its long-term discount rates and once again defying the sky-is-falling predictions of system critics,” wrote Dave Low, executive director of the California School Employees Association.

But despite the good returns, as of July, CalPERS only had 71 percent of funds needed to pay for its long-term financial liabilities, the Sacramento Bee reported. That’s far below the 80 percent funding level that is considered the absolute minimum for a healthy pension system.

This article was originally published by CalWatchdog.com

We Still Need to Reform Deferred Retirement Plans

pension-2In these waning days of the 2018 legislative session, pension reform once again was shoved into the future. That can’t last forever.

One bill I hope to bring back in an upcoming legislative session is Senate Bill 1433, concerning a clever retirement postponement gimmick called a Deferred Retirement Option Plan, or DROP, for police and firefighters. But it’s a DROP kick for taxpayers, and an expensive one.

Let me explain this scheme. In an employee’s last five years with the municipality, they receive their salary and their pension. The pension benefits are deposited into a trust where it earns an attractive rate of interest. At the conclusion of the five years, the trust distributes the final balance along with the compounded interest income.

As the Los Angeles Times reported, new Los Angeles Police Department Chief Michel Moore was given a lump sum of $1.27 million from his DROP plan by first retiring, then being rehired in his new position. “Moore said in an interview that the plan to have him retire and then return almost immediately to work was proposed by former Chief Charlie Beck and approved by Mayor Eric Garcetti.”

I fully understand the motivation and the implementation of this plan. I can see why it is used and how politically difficult it is to discontinue allowing DROP plans as a management alternative.

And I am in no way inferring that Chief Moore and others who take advantage of DROPs are abusing the system. As someone who has earned a Certified Financial Planner designation earlier in my career, I certainly would advise anyone who qualifies for a DROP to take it.

It is the system that is wrong. It needs to be fixed.

Unfortunately, SB 1433 would not affect charter cities such as Los Angeles, which have a great deal of autonomy on such matters. But it would affect what are called ’37 Act counties, short for the County Employees Retirement Law of 1937. SB 1433 would prohibit altogether such a county or district from starting a new Deferred Retirement Option Program, or a public employee in a DROP jurisdiction from now participating in one.

Let’s stop the perception of abuse. Let’s eliminate a temptation that should never have been there in the first place. The experience of DROP participants in Los Angeles between July 2008 and July 2017 is not pretty.

Five points on that from an earlier Los Angeles Times story from April 15:

  1. Police and firefighters in the DROP program were nearly twice as likely to miss work for injuries, illness or paid leave.
  2. Those taking disability leave while in DROP missed a combined 2.4 million hours of work for leaves and sick time, and were paid more than $220 million for the time off.
  3. More than a third of police officers who entered the program, 36 percent, went out on an injury leave. At the fire department, it was 70 percent.
  4. The average time off for those who took injury leaves was nearly 10 months. At least 370 missed more than a year. This comes at a very steep cost.
  5. In addition to the salary and pension payments, leaves taken by DROP participants create a third cost for taxpayers. The fire department pays overtime to fill their vacant shifts. The Police Department requires other officers to cover their work.

Los Angeles is realizing that DROP plans are a mistake after costing the city an estimated $1.6 billion since 2001. Our state legislature should too. It should take a leadership role and totally discontinue allowing this unique strategy.

Sacramento needs to help local governments help themselves in addressing the pension crisis. This year would have been good. Next year, with a new governor and many new legislators, it is critical.

California State Senate, 37th District.

This article was originally published by Fox and Hounds Daily

The California Legislature passes the pension buck – again

PensionsIn truth, Sacramento politicians are very dependable. You can depend on them to raise your taxes, pass meaningless resolutions attacking President Trump and hurt the private sector by eliminating workplace arbitration and enacting even more burdensome regulations. And finally, they are very dependable in avoiding the most important threats to California’s financial solvency, especially dealing with unfunded pension liabilities.

Much has been written about California’s unfunded pension crisis. By 2024, normal contribution payments by cities and counties to CalPERS are estimated to total nearly $3 billion, and the unfunded contribution payments are estimated to total $5.5 billion. That shortfall of nearly $3 billion a year will continue to increase unless reforms are enacted – soon.

California’s pension crisis exists in large part due to the very nature of defined-benefit plans. Unlike defined-contribution plans, where the taxpayers’ obligation to each public employee ends with every pay period, defined-benefit plans depend on a projection of future investment returns. And therein lies the problem. California has been horribly wrong in its application of assumed rates of return, leading to hundreds of billions in unfunded liabilities.

And this shortfall is occurring in good economic times when the state of California is relatively flush. A recession will quickly expose this short-sighted thinking, yet the Legislature continues to believe that local municipalities will continue to pass regressive sales tax increases to bail themselves out. Already, 24 cities have sales tax rates at or over 9.5 percent, and more cities are destined to join them.

To read the entire column, please click here.