How to leave CalPERS without paying huge fee

It may surprise cities that did not switch new hires to 401(k)-style plans because of huge CalPERS termination fees, not to mention the authors of a proposed initiative giving voters power over pensions.

But a CalPERS white paper that surfaced last week describes a “soft freeze” of pension plans that switches new hires to a 401(k)-style investment plan without paying a termination fee.

The March 2011 paper seems to contradict the current California Public Employees Retirement System position: When a pension plan is closed to new members, state law requires that the plan be terminated.

Termination triggers a fee large enough, when conservatively invested in bonds, to pay the pensions promised remaining plan members for decades into the future. The big fee is needed because employers and employees no longer pay into a terminated plan.

In the Stockton bankruptcy, Judge Christopher Klein said a termination fee that boosted the Stockton pension debt or “unfunded liability” from $370 million to $1.6 billion was a “poison pill” if the city tried to move to another pension provider.

One of the co-authors of the proposed “Voter Empowerment” pension initiative, former San Jose Mayor Chuck Reed, has first-hand experience with the big CalPERS termination fee.

The San Jose city council considered switching new council members to a 401(k)-style plan three years ago. But the council made no change after learning the CalPERS termination fee would be $5 million, far above the $900,000 debt or unfunded liability.

Villa Park, with another small plan (30 members, seven active), asked for an estimate to publicize high termination fees. The CalPERS estimate this year was $3.7 million. Canyon Lake and Pacific Grove also balked at high termination fees.
So, why did the CalPERS white paper issued four years ago describe a “soft freeze” that would allow switching new hires to a 401(k)-style plan without terminating the pension plan and triggering a big fee?

A CalPERS spokeswoman said the white paper assumed that the state law covering public pensions, the Public Employees Retirement Law, would be changed to allow a soft freeze without terminating the pension plan.

“The PERL could be changed to permit the soft freeze that is contemplated in the initiative, but the current wording of the initiative does not clarify this,” Amy Morgan, the CalPERS spokeswoman, said via email. “It is this lack of clarity in the initiative that leads to the uncertainty about the consequences of the initiative.”

Among other things, the initiative sponsored by a bipartisan group led by Reed and former San Diego Councilman Carl De Maio requires voter approval of pensions for new hires, government paying more than half of total retirement costs, and termination fees.

The white paper issued in March 2011 was followed in August of that year by a major CalPERS policy change. The investment earnings forecast used to set the termination fee was dropped from 7.75 percent to 3.98 percent, sharply increasing the fee.

The change from the optimistic forecast for the main CalPERS fund, with its diversified portfolio of stocks and other investments, to a less risky and more predictable bond-based forecast was driven by worry that a large plan might be terminated.

CalPERS had been hit by huge recession-era investment losses, about $100 billion, and needed large employer rate increases. There was speculation about possible city bankruptcies, and Stockton and San Bernardino filed the following year.

But no large pension plan has been terminated. The pooled CalPERS fund that pays for the pensions of members in terminated plans, which receive no payments from employers or employees, has a large surplus.

The Terminated Agency Pool had 249 percent of the assets (market value $194 million) needed to pay promised pensions as of June 30, 2013, the latest report said. Annual payments of $4.6 million were going to 684 retirees and beneficiaries of 90 terminated plans.

How important is the termination fee?

It’s the one way, outside of bankruptcy, that the pensions of current workers can be cut. If a terminated plan lacks the assets to cover promised pensions, the CalPERS board has the power under state law to cut the pensions to the level covered by the assets.

The white paper on plan closure was cited by the CalPERS chief executive officer, Anne Stausboll, in a reponse to a request for an analysis of the proposed initiative from the Assembly public retirement committee chairman, Rob Bonta, D-Alameda.

In addition to creating administrative challenges and threatening tax-exempt status and death and disability coverage, Stausboll said, the initiative would abolish the “California Rule” for new hires and possibly current employees.

A series of state court decisions known as the “California rule” are believed to mean that the pension promised on the date of hire becomes a vested right, protected by contract law, that can only be cut if offset by a new benefit of comparable value.

The CalPERS white paper said a “hard freeze” stops future pension earnings for current employees, presumably prohibited by the California rule. A “soft freeze” only closes the pension plan to new employees.

“When a plan administrator closes a defined benefit (pension) plan, often the administrator opens a fixed-rate defined contribution (401k-style) plan,” said the white paper. “The defined benefit plan must be administered until the last participant quits working, retires and dies.”

The white paper lists a number of reasons why staying with pensions is preferable, including lower costs from administering only one plan instead of two plans if new employees are switched to a 401(k)-style plan. A termination fee is not mentioned.

The other large state pension system, the California State Teachers Retirement System, has not had to deal with plan terminations. It has only one plan covering 1,700 employers, mainly school districts but also other education agencies.

In an early analysis of the initiative sent to stakeholders, CalSTRS sees a number of administrative, funding and other problems. The vote on whether to give new hires pensions is assumed to be by each school district or employer jurisdiction, not statewide.

Depending on the vote outcome, CalSTRS said it could be required to administer multiple plans with “inconsistent eligibility requirements, vesting rules, benefit formulas, contribution rates, retirement ages, and beneficiary and survivorship allowances.”

Attorney General Kamala Harris is expected to issue a title and summary for the initiative by tomorrow (Aug. 11). Two previous pension initiatives were dropped after the sponsors said Harris gave them inaccurate and misleading summaries, making voter approval unlikely.

Reporter Ed Mendel covered the Capitol in Sacramento for nearly three decades, most recently for the San Diego Union-Tribune. More stories are at Posted 11 Aug 15

6 Responses to “How to leave CalPERS without paying huge fee”

  1. Michael C Genest Says:

    We see that David Crane has prevailed with CalPERS to a degree! By using the bond-basis rate of return to calculate the termination fee, CalPERS acknowledges the principle that there should be no risk that future generations might have to help pay for current promises.

  2. John Moore Says:

    Re Mr. Mendel’s description of “the California Rule,” the rule only applies “if” and only “if” the employees of that government Agency” were granted “vested” rights by a legislative act as in Kern and Allen(specific Charter provision) or in a non-Charter city by an Ordinance that granted a “vested” pension right(see LiebertCassidyWhitmore Seminar re Vested Rights). Teachers are given vested pension rights by state law, but not so for cities and counties(LCW seminar). MOU’s and contracts with pension systems do not grant vested rights unless the contract over-comes the presumption against the grant of a vested right, a very heavy burden(LCW seminar). CaLPERS “sells” Mr. Mendel’s mis-discription of the California rule, again and again. The damage to pension reform because of the mis-statement of “the California Rule’ is massive. Even many trial Judges have mis-applied the rule and adjudicated the existence of vested rights without the requisite legislative creation of such a right.

  3. Matt Says:

    Sorry, Michael Genest, but your misinformation doesn’t fly here.

    The reason you use a bond rate in terminated plans is because the investment horizon has essentially been shrunk to zero and the assets you can invest in have to be those which have a very low probability of losing any money–ie, bonds. That means investing in a diversified portfolio of stocks/bond/private asset classes is out–and the assumed rate is lowered to reflect the rates bonds will return. It forces current taxpayers to pay more than they should by removing the option to have income from investments pay the lion’s share of the cost of the plans.

    As for John Moore, the California Supreme Court has repeatedly rejected your view on vested rights. See REAOC v County of Orange, a 2011 California Supreme Court case, which affirms that there can even be “implied vested rights.” How many times do you have to be proven wrong on your analysis of vested rights before you stop posting your nonsense?

  4. John Moore Says:

    Re REAOC-The Supreme Court gave the federal court an “advisory” opinion that it was theoretically possible to have an implied “vested right” but the burden to show legislative intent was great. Its opinion went back to the trial court and it found that no legislative intent existed, so the Union lost. The Union Appealed to the full ninth Circuit Ct of Appeals. On Feb 13, 2014, the Ninth Circuit upheld the trial courts decision and confirmed that in spite of decades of MOU’s, no legislative intent to create a vested right was present. The case is “Retired Employee’s of Orange County v County of Orange 742 F3d1137 (2014)”. I forgive you for your nonsense remark. JMM

  5. Matt Says:

    My goodness, John, you simply don’t get it. It wasn’t an advisory opinion–it was a statement of California law. Let me help you by quoting the opening lines of the opinion form the California Supreme Court.

    “At the request of the United States Court of Appeals for the Ninth Circuit, we address the following abstract question: “Whether as a matter of California law, a California county and its employees can form an implied contract that confers vested health benefits on retired county employees.” For the reasons that follow, WE CONCLUDE THAT A COUNTY MAY BE BE BOUND BY AN IMPLIED CONTRACT UNDER CALIFORNIA LAW if there is no legislative prohibition against such arrangements, such as a statute or ordinance.”

    So, again, John, your claim that only a “legislative act” can grant vested benefits is simply—wrong.

    The fact that the court ultimately found the facts in the Orange County case didn’t support that there had been an “implied contract” created has nothing to do with the statement of law.

  6. Daniel Quirk Says:

    Any update on the soft freeze?

    As long as the City agrees to be on the hook for any shortfall related to the existing DB beneficiaries, my understanding is that it shouldn’t change anything from CALPER’s perspective or the City’s perspective in terms of payments/costs. What this would allow is for Cities to stop piling on to it to long term pension cost and gradually transition its work force to DC plans.

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