MOU Fiscal Analysis: Bargaining Unit 2 (Attorneys and Hearing Officers)

On August 23, 2016—with only eight calendar days remaining before the end of the two-year legislative session—the administration submitted to the Legislature a nearly 250-page tentative agreement between the state and Bargaining Unit 2 (Attorneys and Hearing Officers). Section 19829.5 of the Government Code directs our office to produce an analysis of a tentative agreement. This analysis of the proposed Unit 2 agreement fulfills our statutory requirement. State Bargaining Unit 2’s current members are represented by the California Attorneys, Administrative Law Judges, and Hearing Officers in State Employment (CASE). The administration has posted the agreement and a summary of the agreement on its website. (Our State Workforce webpages include background information on the collective bargaining process, a description of this and other bargaining units, and our analyses of agreements proposed in the past.)

If this proposal is approved by the Legislature and Unit 2 members, the Governor will have achieved his goal of implementing a funding plan for retiree health benefit liabilities and reducing retiree health benefits for future Unit 2 members. These actions would lower state retiree health costs significantly over the long term. In order to reach this agreement, however, the Governor agreed to propose various pay and benefit increases for Unit 2 members in the near term. (He has chosen to do this for other state bargaining units too—see our analyses of proposed agreements with Units 6 [Corrections], 7 [Protective Services and Public Safety], 9 [Professional Engineers], 10 [Scientists], and 12 [Craft and Maintenance].) These proposed pay and benefit increases—along with the state contributions to match employee payments to a retiree health funding account—constitute a significant new budgetary commitment for the state with both near- and long-term effects on state obligations.

Major Provisions of Proposed Agreement

If ratified by the Legislature and the CASE membership, this agreement will be in effect through July 1, 2019 and will increase the state’s annual costs for these employees over the course of four fiscal years. In the sections below, we discuss the provisions of the proposed agreement that affect employee pay, employee health benefits, and retiree health benefits.

Salary and Pay

Provides Three General Salary Increases. The proposed agreement increases pay by a specified percentage for all Unit 2 members on three separate occasions—5 percent effective the pay period following ratification of the agreement, 5 percent on July 1, 2017, and 4 percent on July 1, 2018. This is a cumulative increase of 14.7 percent over the course of the agreement. Salary increases also increase state costs for overtime and salary-driven benefits, including state contributions to employees’ pension, Medicare, and Social Security. (In addition—as discussed in greater detail later—the agreement establishes the state’s contributions to prefund retiree health benefits as a percentage of pay, creating an additional cost that fluctuate with pay levels.)

Increases Allowable Annual Cash Out of Vacation and Annual Leave. The current memorandum of understanding (MOU) permits Unit 2 members to cash out up to 20 hours of vacation or annual leave each year. Beginning in 2016‑17, the proposed agreement permits—to the extent authorized by department directors—Unit 2 members to cash out up to 80 hours of vacation or annual leave each fiscal year. Leave is cashed out based on employees’ current hourly pay. These leave cash outs are subject to Medicare and Social Security payroll taxes but do not affect employees’ pension benefits. The administration assumes that departments will absorb these costs within existing departmental resources.

Establishes New—Higher Paid—Workers’ Compensation Judge Classification. Currently, there are about 145 employees working in the rank-and-file classification of Workers’ Compensation Judge (Class Code 6116). These employees are employed by the Department of Industrial Relations and conduct judicial proceedings throughout the state related to disputed claims arising under the Labor Code provisions pertaining to workers’ compensation insurance and safety. Employees in this classification are paid between $94,000 and $118,300 per year, and about 80 percent of these employees currently are at the top step of this range.

As part of the proposed agreement, CalHR agrees to prepare a classification proposal to establish a new classification—Workers’ Compensation Judge II. This new classification would be a rank-and-file classification for employees who meet yet-to-be-established qualifications—likely based on the number of years of experience as a workers’ compensation judge. Once established, the Workers’ Compensation Judge II classification’s salary range likely would be between $98,800 and $124,200. Employees who currently are at the top step of the existing judge classification likely would be eligible to promote to the new classification and receive a 5 percent pay increase under the new classification pay scale. Unless funds are appropriated through a future legislative action, departments would need to absorb any increased costs resulting from this new classification within existing resources.

Increases Lodging Reimbursement in San Francisco. State employees are reimbursed for specified costs incurred while traveling and doing business for the state. In the past, these reimbursement rates typically have been established in MOUs for rank-and-file employees. The administration indicates that it intends to remove reimbursement rates from future MOUs and establish a consistent, statewide reimbursement policy. The proposed agreement moves towards this goal by tying Unit 2 travel and lodging reimbursements to those established through policy memos issued by the administration. The specific reimbursement rates are enumerated in a policy memo incorporated into the agreement (see page 145 of this pdf). The proposed lodging reimbursement rates increase the amount of money a Unit 2 employee may be reimbursed for lodging in San Francisco from $150 per night to $250 per night. The administration assumes departments will absorb these costs within existing departmental resources.

Employee Health Benefits

Increase State Costs for Health Benefits. The state contributes a flat dollar amount to Unit 2 members’ health benefits that was last adjusted in January 2016. The proposed agreement adjusts the amount of money the state pays towards these benefits in January of 2017, 2018, and 2019. For the term of the agreement, the state’s contribution would be adjusted so that the state pays up to 80 percent of an average of California Public Employees’ Retirement System (CalPERS) premium costs plus up to 80 percent of average CalPERS premium costs for enrolled family members—referred to as the “80/80 formula.” The state’s contributions would not be increased after January 2019 unless agreed to in a future agreement.

Eliminate Vesting Period for Dependent Health Benefits. The current MOU requires new Unit 2 members to work with the state for two years before receiving the state’s full contribution towards health coverage for the employees’ enrolled dependents. Specifically, the share of the state’s contribution to dependent health coverage increases over time so that the state pays (1) 50 percent of this benefit in the first year, (2) 75 percent of this benefit in the second year, and (3) the full benefit after the employee has worked two years with the state. The proposed agreement eliminates this vesting period so that the state pays the full contribution towards health coverage of new hires’ enrolled dependents. The administration assumes departments will absorb these costs within existing departmental resources.

Retiree Health Benefits and Prefunding

Current Benefits and Funding. Until recently, like most governments in the U.S., California did not fund health and dental benefits for its retirees during their working careers in state government. This has resulted in large unfunded state liabilities for the benefits. The state now pays for retiree health and dental benefits on an expensive “pay-as-you-go” basis. This means that later generations pay for benefits of past public employees.

Currently, after Unit 2 members retire, the maximum state contribution to their health benefits covers 100 percent of an average of CalPERS premium costs plus 90 percent of average CalPERS premium costs for enrolled family members. (This maximum contributions is sometimes referred to as the “100/90 formula.”) Most Unit 2 members—those hired after 1989—receive 50 percent of the maximum contribution from the state if they retire with 10 years of service, with this amount growing each year until it reaches 100 percent of the maximum contribution if they retire after 20 or more years. The state contribution for the typical retiree who is enrolled in Medicare is sufficient to pay the monthly CalPERS Medicare health plan premium and Medicare Part B premium costs.

Proposed Benefit Changes. The proposed agreement changes future retiree health benefits for Unit 2 members first hired in 2017 and thereafter. The agreement requires future workers to pay more towards their health benefits in retirement. The maximum state contribution for these workers’ future retiree health benefits would be revised to reflect the contribution received by active workers based on the 80/80 formula. In addition, the agreement requires future employees to work longer to receive the maximum state contribution. Under the agreement, employees first hired by the state in or after 2017 will not receive any state contribution for health and dental benefits in retirement unless they work for 15 or more years. After 15 years of service, these workers would receive 50 percent of the revised maximum state contribution to retirement, with this amount growing each year until it reaches 100 percent of the revised maximum contribution if they retire after 25 or more years. In addition, under the agreement, the state’s contribution towards retiree health benefits no longer could be used to reimburse Medicare Part B premiums.

Proposed Funding Changes. The agreement institutes a new arrangement to begin to address unfunded retiree health benefits for Unit 2 members. While the administration’s plan seems to be to keep making pay-as-you-go benefit payments for many years, the new arrangement would begin to fund “normal costs” each year for the future retiree health benefits earned by today’s Unit 2 workers. The agreement deposits those payments in an invested account that would generate earnings and gradually reduce unfunded liabilities over the next three decades or so.

Under the agreement, all Unit 2 members contribute 0.7 percent of pay to a retiree health funding account beginning effective July 1, 2017, rising to 1.3 percent of pay on July 1, 2018, and rising again to 2 percent of pay beginning on July 1, 2019. The state would match these contributions to the trust account. Beginning in 2019‑20, total annual employee and state payments to the account would be about $18 million, which essentially is equal to the actuarially estimated Unit 2 rank-and-file normal costs under the most recent state valuation (specifically, the valuation’s “full funding policy” scenario with an assumed 7.3 percent discount rate.) Under no circumstances would an employee or beneficiary or survivor be able to receive employee contribution to the retiree health funding account, even if the employee leaves state service after a few years and is ineligible for retiree benefits.

Fiscal Effect

Significant New State Budget Commitments. Figure 1 shows the administration’s estimated fiscal effects of the proposed Unit 2 agreement. In total, the administration estimates that the agreement will increase state annual costs by more than $130 million by 2019‑20. This is a large increase in annual state costs for Unit 2 members. For comparison, the total salary and salary-driven benefit cost for Unit 2 members in 2015‑16 was about $650 million.

The state’s 2016‑17 budget plan includes $500 million ($200 million General Fund) set aside to account for possible increased employee compensation costs in the fiscal year for rank-and-file and excluded employees resulting from new labor agreements. Of the $42 million that the administration estimates the proposed Unit 2 agreement will cost in 2016‑17, it assumes that departments absorb more than 40 percent of these costs within existing resources. (Based on our past experience, requiring affected departments to absorb such costs will force some of them to take actions like holding positions vacant in order to pay for the costs.) The administration requests that the Legislature appropriate the remaining $24.3 million ($6.6 million General Fund), with an offsetting reduction in the amount of money the budget has set aside for future labor agreements.

Additional Cost for New Workers’ Compensation Judge Classification. The administration indicates it did not attribute cost to the creation of the new judge classification because the details of the new classification are not certain and likely will not be finalized for several months. Once the new classification is established, it will increase state costs above what is reflected in Figure 1 as rank-and-file employees promote to the new classification. We estimate that the new classification could increase annual state costs by more than $1 million. The administration assumes that departments will absorb this cost within existing resources.

Additional Costs for Managers and Supervisors to Address Existing Pay Issue . . . When rank-and-file pay increases faster than managerial pay, “salary compaction” can result. Salary compaction can be a problem when the differential between management and rank-and-file is too small to create an incentive for employees to accept the additional responsibilities of being a manager. Consequently, the administration often provides compensation increases to managerial employees that are similar to those received by rank-and-file employees. Although the administration has significant authority to establish compensation levels for employees excluded from the collective bargaining process, these compensation levels are subject to legislative review. The administration proposes a number of pay increases in 2016‑17 for managers and supervisors to address existing compaction issues between Unit 2 members and their supervisors. In total, these adjustments would increase annual state costs by $4.4 million. The administration assumes that departments will absorb $1.4 million of this increase within existing resources and requests an appropriation of $3 million from Item 9800, with an offsetting reduction in the amount of money set aside in the budget.

. . . And to Prevent Future Compaction. The administration also proposes higher pay for Unit 2 managers and supervisors in 2016‑17 to prevent compaction resulting from the proposed (1) general salary increase upon ratification of the agreement and (2) creation of the new workers’ compensation judge classification. The administration estimates that addressing compaction issues resulting from these provisions of the agreement will increase state costs in 2016‑17 by $5.9 million. The administration assumes that departments will absorb about $500,000 of this increase within existing resources and requests an appropriation of $5.4 million from Item 9800 with an offsetting reduction in the amount of money set aside in the budget. We estimate that extending the terms of the proposed agreement to employees excluded from collective bargaining would increase annual state costs by 2019‑20 by more than $15 million compared with today’s spending levels. About $2 million of these costs fund the state’s share of the Governor’s plan to prefund retiree health benefits for Unit 2 managers and supervisors.

Leave Cash Outs Can Reduce Long-Term Costs. As we explain in our March 14, 2013 report After Furloughs: State Workers’ Leave Balances, unused leave balances create a liability for the state because the state must compensate employees for any unused leave—at their final salary rate—when employees separate from state service. Employees typically earn their highest salary during their last year of service with the state. We estimate that the total value of Unit 2 members’ unused vacation and annual leave will be more than $80 million after employees receive the first general salary increase proposed under the agreement. Allowing employees to cash out a larger share of their unused vacation/annual leave will reduce the state’s long-term costs associated with these liabilities.

Long-Term Fiscal Effects of Retiree Health Proposals Uncertain. We have long recommended that the state move toward funding normal costs for these benefits. This agreement—according to the best information available now—would achieve that important goal. Over the long term, by generating investment gains in a dedicated retiree health funding account, this approach would significantly reduce state taxpayer costs. In addition, the proposed reduction of future Unit 2 retiree benefits also would significantly reduce state costs over the long term.

The administration has submitted no Unit 2-only actuarial valuation specifically tied to this agreement’s retiree health and dental benefit provisions. Moreover, as with other recent labor agreements, there is no detailed analysis of the complex legal issues involved with the new retiree health provision. If the Legislature and Unit 2 members approve this agreement, it will be important to monitor future state actuarial valuations to see if the new funding plan is on track to achieve the goal of eliminating Unit 2 unfunded liabilities over the next 30 years or so.