How more generous pensions boosted city costs

CalPERS sponsored legislation resulting in more generous city police and firefighter pensions, SB 400 in 1999, a well-known issue in the debate about whether growing pension costs are “unsustainable.”

But CalPERS also backed legislation, AB 616 in 2001, giving most local government employees the option of bargaining for generous pensions once limited to police and firefighters, who face hazardous duty and may need to retire early from their physically demanding work.

The “3 at 50” pension for police and firefighters in SB 400, which provides 3 percent of final pay for each year served at age 50, is capped at 90 percent of final pay. There is no cap on the three AB 616 pension formulas.

The most generous of the three AB 616 formulas for non-safety or “miscellaneous” employees, “3 at 60,” provides a pension at age 60 that is 90 percent of final pay after 30 years of service and 120 percent of pay after 40 years of service, according to a CalPERS benefit chart.

Why provide a monthly pension payment that is higher than the monthly paycheck earned on the job?

“The 3% at age 60 formula encourages skilled workers with invaluable experience to stay in their jobs longer,” said a CalPERS analysis of AB 616. “If public agencies are willing to pay for the higher formulas in order to increase the benefits they provide to their employees, they should be allowed to do so.”

Another CalPERS analysis of the bill said it could be argued, on the other hand, that the “enhanced benefit” provided by the “3 at 60” formula, which begins with 2 percent of final pay at age 50, will “encourage earlier retirement for some employees.”

All three of the AB 616 local government formulas, including “2.5 at 55” and “2.7 at 55,” are more generous than the “2 at 55” formula received by most state workers hired before a pension reform on Jan. 1, 2013.

CalPERS calls employees hired before the reform “classic” members. Employees hired after the reform have a cost-cutting miscellaneous pension formula, “2 at 62,” and are called “PEPRA” members, the abbreviation for Public Employees Pension Reform Act.

Like most CalPERS miscellaneous formulas the “2 at 55” received by state workers is uncapped. At age 60 with 40 years of service the formula provides a pension of 90.48 percent of final pay, much less than the 120 percent provided by the “3 at 60” formula.

How many CalPERS members retire with pensions of 100 percent or more of their final pay? A poorly worded Calpensions public records act request to CalPERS last year yielded 2,217 names with no time frame, employer or pay and pension amounts.

About 40 percent of the local government CalPERS classic miscellaneous plans provide the three AB 616 formulas. According to a CalPERS public agency summary 112 plans are “3 at 60,” 276 plans “2.75 at 55,” and 242 plans “2.5 at 55.”

As an incentive to adopt the more generous AB 616 formulas, CalPERS offered to ease the cost for local governments by inflating the value of their investment funds from 90 to 95 percent of market value, drawing opposition from the chief actuary then, Ron Seeling.

As the sponsor of SB 400, CalPERS gave legislators a 17-page pamphlet with a quote from the CalPERS president then, William Crist. He said the pension increase would not cost “a dime of additional taxpayer money,” a phrase often cited later as employer rates soared.

A legislative analysis of SB 400 said CalPERS expected the state employer rate to “remain below the 1998-99 fiscal year for at least the next decade.” Not mentioned in the pamphlet or legislative analysis was a word of caution from CalPERS actuaries.

One SB 400 scenario given the CalPERS board in June 1999 showed that if investment earnings averaged 4.4 percent, instead of the 8.25 percent forecast, the artifically low annual $159 million state payment to CalPERS could soar to $4 billion in a decade, which happened.

Last month a pension sustainability study by Bartel Associates actuaries for the League of California Cities said the “most prominent source” of CalPERS cost escalation began with state and local “enhanced pension benefits” granted following SB 400 and AB 616.

“Cities throughout California followed the state’s lead in providing enhanced benefits and, when negotiated, statute required those enhanced benefits apply to both prior and future service,” said the Bartel study.

“These enhanced benefits have caused a ripple effect that have fundamentally altered the way in which local agencies can retain employees and provide basic and critical services to the public.”

Over the next seven years, the study found, city CalPERS costs will increase more than 50 percent and reach 15.8 percent of the average general fund, nearly doubling from 8.3 percent a decade ago and forcing revenue increases or service cuts.

Four other factors were cited in addition to more generous pensions: investment losses, automatic cost-of-living adjustments, a policy that delayed payment of debt or “unfunded liability,” and a demographic change causing debt for retirees to exceed debt for active workers.

Among “classic” employees hired before the reform the study found a costly gap between projected CalPERS rate increases for those with pensions increased or “enhanced” after SB 400 and AB 616 and those with “unenhanced” pensions.

When a big rate increase is fully phased in by fiscal 2024-25, the average CalPERS rate for “safety” or police and firefighters with enhanced pensions is projected to be 60.3 percent of pay, far above the rate for unenhanced pensions, 37 percent. (see chart above)

A smaller rate gap is projected in seven years for classic non-safety or “miscellaneous” employees: an average 36.7 of pay for pensions enhanced by the AB 616 formulas, compared to an average rate of 28.1 percent for unenhanced pensions. (see chart at bottom)

As a booming stock market gave CalPERS a surplus at the end of the century, equity was a leading argument for raising pensions. The 17-page pamphlet for SB 400 was titled: “Addressing Benefit Equity: The CalPERS Proposal”.

A reform gave state workers hired after July 1, 1991, a lower formula, “1 at 60,” than the “2 at 60” formula received by state workers hired earlier. The inadequate lower formula hurt recruitment, said the pamphlet, and side-by-side state workers doing the same job received different benefits.

Another inequity, said the pamphlet, was that two-thirds of CalPERS local government members received a “2 at 55” pension, more generous than the state worker formulas. In small type on three pages the pamphlet listed nearly 400 local governments with a “2 at 55” formula.

SB 400 gave most state workers a retroactive “2 at 55” formula, retirees received a one-time permanent pension increase of 1 to 6 percent, and the Highway Patrol received the “3 at 50” formula that also was made available to local governments.

Two years later the equity argument was used again. Backers of AB 616 said local safety employees were enabled by SB 400 to negotiate a 50 percent increase in their pensions, while local miscellaneous workers were not offered a similar benefit increase.

“This bill seeks to provide a local option formula for these members that would increase their retirement benefits by 33 percent,” said a legislative analysis of AB 616.

Now there is a new equity issue. The PEPRA reform cost-cutting formulas for new hires, “2 at 62” for miscellaneous and “2.7 at 57” for top safety, are less generous than the pensions received by classic state and local government employees under SB 400 and AB 616.

The League of California Cities “sustainability principles” call for a “single benefit level for every employee” and converting employees in pre-reform or classic plans to PEPRA formulas for work they do in the future.

As cities opposed more employer rate increases last fall, officials from Hanford and Benicia told the CalPERS board some of their unions are willing to negotiate switching to lower-cost pensions, but current state law does not allow it.

“Currently, the Public Employees’ Retirement Law (PERL) provides different benefit formulas for pre-PEPRA (i.e. Classic) employees,” Amy Morgan, CalPERS spokeswoman, said via email.

“Any modification in benefit design would require legislation and will be analyzed in accordance with contact clause of the state and federal constitutions. CalPERS administers pension benefits in accordance with the PERL.”

The state Supreme Court has agreed to hear appeals of two cases pension reformers hope will weaken or eliminate the “California rule,” a series of court decisions said to mean the pension offered at hire can’t be cut without providing a comparable new benefit.

Reporter Ed Mendel covered the Capitol in Sacramento for nearly three decades, most recently for the San Diego Union-Tribune. More stories are at Calpensions.com. Posted 5 Mar 18

23 Responses to “How more generous pensions boosted city costs”

  1. rstein171 Says:

    We’re constantly trying to put band aids over the wound, but the only way to heal the wound is to change Defined Benefits to Defined Contributions, like the rest of the world.

    Since the public pension system is severely underfunded, city governments need to fund the retirements of former employees by taking money from government services as the increasing pension costs will likely continue to crowd out resources that otherwise would go to public assistance, recreation, libraries, health, public works, and in some cases public safety. Benefit costs are slowly crowding out the discretionary money available for states, districts, and schools to spend on other priorities.

    “Defined retirement benefits” are creeping into budgets, especially when those benefits are underfunded. The unintended consequences are that it’s unfortunate that future generations, unable to vote today, will bear the costs of many enacted pension programs, entitlements and boondoggle projects, requiring the younger generations to pay higher taxes and work later into their lives to pay for these promises.

    The international business world is intelligent enough to know that DEFINED BENEFITS, neither capped nor precisely quantifiable in advance financial disasters to any business, thus all businesses focus on the known, i.e., defined CONTRIBUTIONS alone.

    Stealing from the young who have no votes, but silently shoulder the costs and bear the burden of unfunded promises of these programs to enrich the old seems to describe the Governments expansion of entitlement benefits and other government services, along with the taxes young people will have to pay to support them, mostly to subsidize older Americans.

    Even before those young folks can vote, our Golden State schools are on track to force substantial budgetary cutbacks on core education spending, as public schools around California are bracing for a crisis driven by skyrocketing worker pension costs that are expected to force districts to divert billions of dollars away from education and other government services.

  2. moore Says:

    U.S. News % World Reports just ranked Ca. with the lowest quality of life in the U.S. SB 400 and AB 616 in combination with “entitled” salary increases is a major cause of the decline in living quality in Ca..

    AB 616 is particularly enlightening. Why? Because in 2001 CaLPERS had waived annual contributions of 8.5% of Present Value of Benefits(a cost of $8.5M per $100M in liability) and lost 7.5% of its market value of assets, a cost of 7.5% of liability, for a total cost of about $16M per $100M of pension liability. But, no matter that the system was under water, it adopted the incredible increases, destruction of the quality of life in the state be damned.

    Run of the mill govt. union members are like Ruth Maddoff, they feel no responsibility for their multi-million dollar wind-fall. Local legislative bodies continue to feed the pension junkies with salary increases that fuel greater pension deficits and annual contribution increases.

    Dumb-Ass reform groups plead for the supreme court to fix the problem, implying that local agencies don’t have the legal ability to fix the pension scam. The supreme court will hold that local agencies with pension plans in dire financial straits may reduce pensions w/o off-setting benefits(that is in fact the current law), but it won’t make an iota of difference.

    The only reform of the scam requires legislative majorities with an agenda that mathematically assures a fix. Reformers haven’t even prepared that agenda. Granted it will take a lot of work and analysis to determine a certain fix, but, it is time for the data groups to get at it. We have ample cry-baby data.

  3. SeeSaw Says:

    BS! Planners know that it is wise to offer public-sector employees supplemental DC plans to go along with the DB plans that will provide their sustainability after retirement. Millions of dollars were lost by 457 DC plan holders in the 2008 financial collapse. In the present, it is good to have the DB plans to rely on while riding that DC wave which will always have its ups and downs. All individual public entities in CA had the choice of adopting new benefit formulas enacted by State legislation in 1999 and 2001, or not, and they still have the choice of designing their own budgets and going to the table with their own principles to figure out what they can and must do to keep themselves solvent going forward. How about a cap on vacation accrual and sick leave–I have read many times about public retirees cashing in their unused benefits for hundreds of thousands of dollars when they retired. My entity capped vacation accrual and sick leave cash out–with 36 years of service credit, I grossed $23,000 by cashing out those two benefits–$13,000 after taxes.

  4. S Moderation Honestly Says:

    Theoretically, the lower miscellaneous pension formulas ( pre-1999; 2%@60, post 99, 2%@55, post PEPRA, 2%@62) were meant for those coordinated with Social Security. The higher formulas (3%@60) were meant for those not in Social Security. Cities could pay higher normal costs because they were not contributing 6.2% to SS.

    Theoretically.

    I know there were some cities which had both SS and higher pension formulas.

  5. Tough Love Says:

    S Moderation Douglas,

    Public Sector workers in SS should get a DB Plan no greater than the FEDERAL-worker DB Plan ……. 1% of pay.

  6. Legal Scholar Says:

    The California Supreme Court will not even address the California Rule in the CalFire case. They will simply hold that the statute that created airtime didn’t create a vested contract right (to buy airtime before an active employee retires). End of issue.

    But there is a possibility that the court will confront the California Rule in the Marin case (where review has been granted, but briefing hasn’t even begun) or the Alameda case (which hasn’t even been grated review). If the court determines that the legislation that allowed for pension-spiking didn’t create a vested contract right, once again, the court will not have to address the validity of the California Rule.

    Finally, even if the court (in one or more of those caes) modifies the California Rule, the court may still give its opinion only prospective application because of the fact that employees relied upon the rule for the last 60 or so years.

    In sum, don’t bet that the California Rule will be modified any time soon.

  7. spension Says:

    There is a method to fix the pension issue that has been used 10-20 times in US history… California can go into sovereign default.

    Then *all* of California’s debt can be renegotiated. I don’t know why pension debt is thought to be a different category than bonds or future road maintenance or health care.

    Debt is debt. Fungible. When California has obligated itself to too much future debt, there is a mechanism to rescope *it all*.

    Going after one slice of debt (that to pensioners) while leaving untouched all the bond debt to Goldman Sachs, China, etc seems pretty distorted.

    Seems to me Iceland did just fine after it defaulted. Most countries do better after a default than if they drag the problem out for a long time, like Greece has done due to EU management.

  8. SeeSaw Says:

    @Spension – How about showing some documentation on when and where those 10-20 sovereign defaults occurred.

  9. spension Says:

    23 State defaults in US history documented in:
    http://expectedloss.blogspot.com/2012/05/safety-of-state-bonds-historical.html

    Odd that the debt due to bonded indebtedness doesn’t seem to be computed the same way as that for pension obligations. Why isn’t there a bond fund (like a pension fund) that should have assets on hand to cover the present value of future bond obligations?

    Extend that to everything the government does… why isn’t there a maintenance fund that must cover present value of future maintenance? Etc etc etc.

    Somebody will say something about accounting rules, which is a fake answer. All future debt should be subject to identical accounting rules.

    But most likely… political foes of pensions have bent the accounting rules to make pensions look bad. And bury all the payouts of taxpayer dollars to the powerful men who run the US.

    Anyone else notice how few women are on the list of high pension earners at Transparent California? Occurred to me when I noticed that most of the West Virginia teachers on strike are women.

    Anyone else notice that rank-and-file teachers (largely women) in California have generally the lowest pensions per service year in California? That old Capitol Matrix Consulting report…

    “Teachers. Retirement benefits received by this group are significantly less generous than most other public sector employees. This is partly because teachers covered by CalSTRS are not in social security, their retiree health care is provided by school districts and tends to be less generous than the State of California, and their pension formulas for those terminating before full retirement age is less generous than other public funds.”

    http://www.sjrecycles.org/DocumentCenter/View/3978

    I’d guess… simple misogyny.

  10. SeeSaw Says:

    Thank you Spension. I would surely not want to see us go back two centuries…………..terrible idea…….

  11. Tough Love Says:

    Quoting Spension ……….

    “Odd that the debt due to bonded indebtedness doesn’t seem to be computed the same way as that for pension obligations. Why isn’t there a bond fund (like a pension fund) that should have assets on hand to cover the present value of future bond obligations?

    Extend that to everything the government does… why isn’t there a maintenance fund that must cover present value of future maintenance? Etc etc etc.

    Somebody will say something about accounting rules, which is a fake answer. All future debt should be subject to identical accounting rules.”
    ——————————–
    Suppose we “borrow” (i.e. issue Bond debt) to build a Bridge for say $100 Million, and simply for discussion purposes assume that we could build it in one day, on the SAME date the money arrives, paying the contractors with that money. Let’s also assume that tolls will be put in place to pay the Bond interest & amortization of the Bond Principal.

    On day 1, “the present value of future bond obligations” is the original Bond amount borrowed ………. gone to pay the contractors. But you seem to believe that we should have ANOTHER pot of money on hand equal to what we borrowed.

    Make no sense……. but I’m quite certain that you will dig in your heels and argue that such is correct and proper.

  12. Tough Love Says:

    Follow-up to my above comment ………

    Spension, There is a VERY big difference between “Capital Expenditures” for which borrowing is appropriate (and for which we will NOT have any money on hand to pay it off other than from future revenue … tolls or taxes), and “Operational Expenses” such as employee compensation (of which pensions are a component).

    “Borrowing” to pay for Operational Expenses is a BIG financial non-no. If pensions (i.e., “deferred compensation”) are to be granted, a CONSERVATIVE estimate of the full value of each year’s accrual should be set aside in the year of accrual.

    Of course (re Public Sector pensions) it’s not working out that way because (to buy votes of the workers and get campaign contributions from the Unions), our Elected Officials promise ludicrously generous pensions but extremely low-ball the cost (via ultra-liberal valuation assumptions & methodology) thereby creating the unfunded liability.

  13. Tough Love Says:

    2-nd follow-up………..

    And of course granting retroactively applied pension increases/enhancements, thereby INSTANTANEOUSLY creating a (often HUGE) completely unfunded liability

  14. spension Says:

    Yes, Tough Love, I disagree. You are trapped into some sort of mindset that there are categories of debt that can be separated. To me, debt is debt.

    For some reason accountants take one category of debt (pensions) and demand a fund be on hand at the present value to pay for future expenditures of that category.

    For other types of debts (bonds) we borrow upfront on the assurance of a future revenue stream from taxes.

    Seems to me that the financing of the second type of debt is more edgy and less secure. Indeed the difference is: in the first case you save up for future expenditures. In the second type you spend up front and pay back later.

    I’m a saving-up in advance kind of girl. TL, you seem to like (and be uncomfortable with defaulting on) the second type of promiscuous dept… spend spend spend and then tax tax tax. Spend and tax, spend and tax. That is what you like.

  15. spension Says:

    See Saw… perhaps the terrible thing is to go into debt in the first place, beyond the means of cities and counties and states to pay off that debt. Leaving within one’s means is usually a good philosophy.

    Having said that, military pensions in the US are just as poorly funded as state and local level public pensions. Nobody ever seems to make a peep about the $100 billion or so that the US government is spending these days on unfunded liability and normal payments of military pensions. That is the proof that this is all political… conservative pension hawks love to overspend on the federal dime to pay for DB pensions for their idols, the military. But they dislike the women who get state teacher’s pensions… likely misogyny.

  16. Tough Love Says:

    Quoting spension ……… “Yes, Tough Love, I disagree.”

    I’m not one bit surprised.
    ____________

    And FWIW, I support LESS spending and LESS taxation (to pay for it) ………. and, FAR few (and MUCH lower compensated) Public Sector workers.

  17. CalPERSon Says:

    rstein171 wrote: “We’re constantly trying to put band aids over the wound, but the only way to heal the wound is to change Defined Benefits to Defined Contributions”

    I respectfully disagree. Mathematically it is possible to design a DB plan that is just as sustainable as a DC plan.

    Let’s say you have a DC plan that contributes $1,000 per month to a 401(k) style plan. A DB plan can be designed that takes the same $1,000 per month and pools it into a pension system that invests for the long haul with good but not exorbitant benefits.

    The City of Fresno has done just this. Their DB plan is over 100% funded, which means they are in a better position than if they were DC.

  18. Tough Love Says:

    Quoting CalPERSON ………… “Let’s say you have a DC plan that contributes $1,000 per month ”

    With the “average” wages about $75K annually, $1,000/mo translates into 16% of pay.

    Sure, a 16% of pay contribution every year (and wisely invested) should lead to a reasonable retirement pot, but Private Sector workers typically get about 3% from their employers, not 16%.

    I’m convinced that your REAL concern is that If you had to get your retirement benefits via DC Plans, you couldn’t hide how ludicrously generous they are right now (via current DB Plans).

  19. SeeSaw Says:

    My private sector spouse’s DB pension isn’t enough to pay the ABC Medical Insurance Premium to supplement his Medicare. That’s what I consider, “ludicrous”.

  20. spension Says:

    CalPERSon… of course every mathematically literate person knows that for a given benefit in retirement, DB are more economical than DC, due to the elimination of longevity risk.

    In California mathematically illiterate politicians did raise the benefit level too high. Of course in Washington DC, similarly mathematically illiterate politicians have done exactly the same thing for military retirees…. 2.5% per service year, and retirement possible at age 37. Pension hawks like Tough Love are all in for spend and tax, spend and tax for their buddies like military retirees, most of whom never have seen battle outside of bureaucratic infighting.

    Everyone literate knows that the private sector pension system was drained by corrupt private sector executives, often taking taxpayer pay-ins from defense companies and health industry companies… subsidized by medicare and medicaid. Again, pension hawks like Tough Love are all for their private sector executive buddies getting super-rich off of taxpayer payments.

    It is just teachers, usually female, that pension hawks dislike and want to destroy the pensions for by accusations of being undeserving.

  21. S Moderation Honestly Says:

    “of course every mathematically literate person knows that for a given benefit in retirement, DB are more economical than DC, due to the elimination of longevity risk.”

    I agree one hundred percent.

    However…

    I also do not =disagree= with John Bury, and many others, who say that governments generally cannot be trusted to run them properly.

    He and others may be correct, but, optimist that I am, I say, don’t throw out the baby with the bathwater…

    see…

    David Crane: Fix defined-benefit pension plans, don’t dump them

  22. spension Says:

    Except, S. Moderation Honestly, the private sector cocked up its pension system **EVEN WORSE** than governments. Read “The Retirement Heist” by Ellen Schultz, Pulitzer-winning reporter for the Wall Street Journal, http://www.retirementheist.com.

    Plenty of governments around the Country and World… States of Washington, South Dakota, Wisconsin…. Netherlands, Norway, etc… run perfectly fine DB systems.

  23. S Moderation Douglas Says:

    I read it a year or two ago, on your recommendation. Thank you.

    Pensions -and- retiree healthcare.

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