How California public agencies can reform pension benefits

In 2011, after the Great Recession left California Public Employees’ Retirement System (CalPERS) only 61 percent funded, the Little Hoover Commission gave a dire warning: “California’s pension plans are dangerously underfunded, the result of overly generous benefit promises, wishful thinking and an unwillingness to plan prudently. Unless aggressive reforms are implemented now, the problem will get far worse, forcing counties and cities to severely reduce services and lay off employees to meet pension obligations.”

The Commission’s report ultimately led the Legislature to enact the California Public Employee Pension Reform Act (PEPRA) in an effort to limit pension benefits and improve CalPERS’s financial situation.  However, after nearly a decade of market growth and increased contributions by both employees and employers, the situation is not fundamentally different today, and CalPERS remains underfunded. With fears of another recession looming, public agencies need to plan ahead to address the impact of CalPERS’s financial struggles.

Although CalPERS has taken steps to reduce its unfunded liability, the burden fell largely on employers. For example, CalPERS changed its actuarial policies to shorten the payment period for unfunded liabilities. For employers, this means higher up-front costs in exchange for long-term savings. CalPERS has also reduced its “discount rate” – its assumed investment returns – from 7.5 percent to 7 percent, meaning employers must pay higher contributions to cover a given benefit. However, CalPERS’s own investment advisor estimates expected returns as closer to 6 percent, and if returns fail to meet the 7 percent target, CalPERS will likely increase contribution rates further to cover the shortfall.

Between CalPERS’s efforts to reduce unfunded liabilities and the benefits already accrued and payable, many public agencies are finding that increasing pension costs are beginning to crowd out any discretionary spending, reducing the funds available for staffing and public services. Managing these costs is a difficult task, as the law limits the available options. For example, constitutional principles relating to vested rights make it difficult to alter benefits payable to existing retirees. And agencies thinking about reducing pension benefits must ensure they bargain over proposed changes to the extent required by the Meyers-Milias-Brown Act. Understandably, employees and labor organizations are often hesitant about proposals that could reduce existing benefits.

In the past, a common tool was to negotiate lower benefits for future hires, while preserving benefits for existing employees and avoiding any impact on vested rights. For most agencies, this is no longer possible under PEPRA. PEPRA imposed a single lower pension tier for “new members” (generally, those who first became CalPERS members in or after 2013), but also requires that all “classic members”, including lateral hires, must receive the same benefits as if they had been hired in December 2012. The exception is for safety members, where PEPRA provides three available benefit formulas, meaning the employer may still have room to negotiate lower benefits for future “new” members.

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

To read the full version of this article, visit American City & County.