December 22, 2011
Pursuant to Elections Code Section 9005, we have
reviewed the proposed constitutional initiative concerning public
employee pensions (A.G. File No. 11‑0063, Amdt. #1S).
Background
Existing Public Employee
Pensions. California governments generally offer comprehensive
pension benefits to their employees, which are funded from public
employer and public employee contributions, as well as investment
earnings generated from those contributions. Some governments also
contribute to retiree health benefits for their former employees.
Types of Retirement Plans.
In general, California public employees are enrolled in defined
benefit pension plans, which provide them with a specified
benefit—generally based on their salary levels near the end of their
career, their number of years of service, and the type of job they had
while in public employment. This is called a defined benefit pension
plan, and public employees generally are obligated to contribute only a
fixed amount—as a percentage of their pay each month—to these plans.
Public employers and employees generally are
required to contribute the amount estimated by actuaries as the “normal
cost” for plans each year. Normal costs are the amounts estimated to be
necessary—combined with future invested returns—to pay for benefits
earned by employees in that year. To the extent that the plans do not
have enough money over time to pay for benefits, an unfunded liability
can result—due, for example, to lower-than-expected investment returns
or decisions to give retroactive benefit increases that apply to prior
years of service. In general, public employers bear all of the
responsibility to pay for such unfunded liabilities. As of 2008‑09, the
most recent year for which data are available from the State
Controller’s Office, public employers paid a total of about $14 billion
to pension systems to cover benefit costs, including several billion
dollars to pay for unfunded liability costs.
Many California governments also provide their
employees with options to contribute funds to defined contribution
retirement plans, which are common in the private sector. Defined
contribution plans do not promise a defined benefit like those described
above. Instead, these plans are able to provide retirees with income
generated from prior contributions plus available investment returns.
Employers have no obligation to provide additional money to employees’
defined contribution accounts to offset lower-than-expected investment
returns.
In addition to defined benefit and defined
contribution plans, many California public employees also are eligible
to receive Social Security benefits. Teachers and many public safety
workers, however, generally are not eligible for such Social Security
benefits.
Contract Clause. Courts
have ruled that public employees in California accrue certain rights to
pension benefits on the day that they are hired and, over time, they
typically accumulate more pension benefit rights. Contracts related to
pensions sometimes are included in collective bargaining agreements or
in statutes, but in some cases, they may be “implicit” (or unwritten)
commitments based on their employer’s past practices. Both the U.S. and
California Constitutions contain a clause—known as the Contract
Clause—that prohibit the state or its voters from impairing contractual
obligations. Interpreting these Contract Clauses, California courts have
ruled for many decades that pension benefits for current and past public
employees can be reduced only in rare cases—generally, when public
employers provide a benefit that is comparable and offsets the pension
contract that is being impaired or when employers previously have
reserved the right to modify pension arrangements.
Proposal
This measure amends the California Constitution
to impose new requirements and limitations concerning public employee
retirement benefits and the funding of those benefits by public
employers and employees. The measure establishes different retirement
benefit requirements for public employees hired before July 1, 2013
(referred to below as “current public employees” or “current employees”)
and public employees hired on or after July 1, 2013 (referred to below
as “future public employees” or “future employees”). Assuming the
measure is adopted by voters in November 2012, current employees,
therefore, would include public employees hired between the date this
measure is adopted and June 30, 2013.
Pensions for Employees Hired On or After July 1, 2013
This section describes this measure’s limitations
on retirement benefits and the funding of such benefits for future
public employees. On or before June 30, 2013, state and local elected
leaders would be required to adopt measures providing for benefits
consistent with the measure.
Current System of Defined Benefit
Pensions Would Be Changed Substantially. For future public
employees, this proposal prohibits state and local governments from
accumulating pension debt or unfunded liabilities and requires them to
retain the exclusive authority to modify the terms of defined benefit
and defined contribution retirement plans at any time. Benefits for
future employees, therefore, would differ markedly from those currently
offered to California’s public employees. Under this proposal, for
example, future public employees—and not public employers—would have to
bear all financial risk for
unfunded liabilities. For future public employees, this means that their
retirement income plans would have to (1) allocate all future unfunded
liability costs for defined benefit pensions to the employees themselves
or (2) be structured as defined contribution plans or similar plans,
instead of the defined benefit pension plans now offered to current
public employees.
Public Employer Contributions to
Pension Plans Limited. Under this proposal, for future employees
covered by Social Security, a public employer’s total contribution to an
employee’s defined benefit, defined contribution, and other retirement
plans could not exceed 9 percent of pay for safety employees (such as
police and firefighters) and 6 percent of pay for non-safety employees.
For employees who are not eligible for Social Security, including
teachers and many public safety employees, employers and employees also
would share equally the cost of an additional defined benefit pension
that would “as precisely as possible” match benefits provided by the
Social Security program. (The measure specifies that after 30 years of
service and attaining the age of 58, future public safety employees
would be eligible to receive the full benefit of this pension. The
measure does not specify at what age or length of service future
non-safety employees would be eligible to receive this full benefit.)
This measure also requires that future employees
contribute an amount—presumably in each pay period—to their pension and
defined contribution retirement plans that is at least equal to the
amount contributed by their public employer, and it prohibits employers
from making any contributions to plans on behalf of future employees.
Pensions for Employees Hired Before July 1, 2013
This section describes this measure’s limitations
of retirement benefits and the funding of such benefits for current
public employees.
Pension Modifications for Current
Employees Retiring After June 2016. Under this measure, a
current employee who retires after June 30, 2016 would be able to
receive pension benefits based only on the average of his or her highest
three years’ average annual base wage.
Annual Review of Plans’ Funded
Status. This measure requires the administrator of each defined
benefit retirement plan for current employees to obtain an independent
review of the plan’s assets and liabilities and determine the plan’s
funding status each year. This independent review would have to follow
potentially stricter standards than those currently used by California’s
defined benefit public pension systems—specifically, the accounting
standards and assumptions established by federal law for private-sector
pension plans, including those established by the federal Employee
Retirement Income Security Act (ERISA). If the independent review
determines that a plan’s assets cover less than 80 percent of its
liabilities, based on the standards included in the measure, the plan
would be considered “at risk.” Once a plan is considered at risk, the
public employer would be required to either (1) appropriate the funds
necessary to fund the plan above the at-risk level or (2) find and
declare that making the appropriation necessary to fund the plan above
the at-risk level would impair the public entity’s ability to provide
essential governmental services. If a public employer makes the latter
declaration, the measure (1) requires employees to contribute more to
the plan until the plan’s funding exceeds the at-risk level, and (2)
gives the affected employees the right to withdraw from further
participation in the at-risk plan and enter into the retirement plan
available to future employees. Moreover, current employee and public
employer contributions would change as described below so long as
pension plans are deemed at risk.
Contributions to Pay for Normal
Costs of At-Risk Pension Funds. Under this measure, if a public
employer declares that it cannot fund an at-risk plan for current
employees without impairing essential services, the public employer
would be required to limit its contributions to the normal cost to
6 percent of a non-safety employee’s pay and 9 percent of a safety
employee’s pay. Public employers, however, would contribute some
additional amount for employees who do not participate in Social
Security. The balance of the normal cost generally would be contributed
by current employees, provided, however, that current employees’ share
of pension costs could not increase by more than 3 percent of pay per
year. (If this 3 percent of pay limit, however, otherwise would result
in normal costs not being fully funded in any year, the public employer
would be required to make additional contributions above the limits
described earlier to ensure that normal costs are fully funded each
year.)
Contributions to Pay for Unfunded
Liability Costs of At-Risk Pension Funds. If a public employer’s
contribution to the normal cost of an at-risk plan under this measure is
less than it contributed before the plan was considered at risk, the
employer would contribute the difference to the unfunded liability of
the fund. The measure states that public employers would be able to
require employees to make additional contributions to the unfunded
liability determined to be “necessary and equitable,” but the employee’s
aggregate contribution to normal costs and unfunded liabilities never
could increase by more than 3 percent of pay each year. There is no
limit to the total amount of pay current employees contribute to plans
as long as their contributions do not increase by more than 3 percent of
pay each year.
Other Provisions
The measure makes a number of other changes to
the retirement benefits received by public employees and the systems
that provide those benefits.
Death and Disability Benefit
Administration Changes. Public employers that provide retirement
benefits for their employees may also “separately provide” death and
disability benefits to their employees, regardless of the employee’s
date of hire. The cost of such death and disability benefits is not
subject to the cost limitations established by the measure. Death and
disability benefits for employees hired on or after July 1, 2013 would
have to be provided separately from the system that administers their
pension, defined contribution, or similar retirement benefits.
Retroactive Benefits Prohibited.
Under this measure, public employers no longer would be able to provide
increases in pension plan benefits or formulae applicable to prior years
of service—otherwise known as “retroactive increases” in employees’
pension benefits.
Limits on Cost-of-Living
Increases for All Current and Future Retirees. For all current
and future state and local retirees, this measure states that it would
amend existing pension benefit contracts to limit annual percentage
cost-of-living increases after December 31, 2012, to no more than the
annual Social Security cost-of-living increase.
Pensions for Certain Felons
Prohibited. This measure provides that a public employee
convicted of a felony arising out of his or her service to a government
agency cannot receive public pension benefits for his or her service to
“such government agency.” (It is not entirely clear whether this would
prohibit the felon from receiving pension benefits related to their
service for another
government agency, for which there was no related felony conviction.)
“Air Time” Purchases Generally
Prohibited. This measure prohibits government employees from
purchasing additional retirement service credit—often called air
time—for any period that does not qualify as government service or
military service.
Pension Contribution Holidays
Generally Prohibited. Both public employers and employees would
be required to contribute to the normal cost of defined benefit pension
plans each year unless the plan is more than 120 percent funded under
the various private-sector, ERISA, and other funding standards described
in this measure for evaluating the at-risk status of current employees’
pension plans.
Alterations to Future Pension
Benefit Accruals. This measure requires public employers to
reserve the right to make prospective changes to pension, defined
contribution, and similar retirement benefits at their sole discretion.
(It appears that this change would apply to current—as well as
future—employees under this measure.)
Changes to Composition of Public
Retirement Boards. This measure amends existing constitutional
provisions related to the composition of California’s public retirement
system boards. Under this measure, beginning on July 1, 2013, at least a
majority of the members of the governing board of every public
retirement system would be required to (1) have demonstrated expertise
in a specified area and (2) not be members or beneficiaries of any
California government pension plan or retirement system or have
immediate family members who are members or beneficiaries of such a plan
or system. In addition, the state’s Director of Finance—an official
appointed by the Governor with the advice and consent of the State
Senate—would serve as a voting member of any state or local pension
system with total liabilities that exceed $5 billion. (Because this
$5 billion figure is not adjusted for inflation, over time, the Director
of Finance probably would join each public pension board in the state.)
Judges Excluded From the Pension
Limits. This measure applies its various pension plan changes to
current and future public employees, which the measure specifically
defines to exclude California’s judges. Accordingly, the judges’
retirements plans—administered by California Public Employees’
Retirement System—would be unaffected by this measure.
State Contract Clause Would Not
Apply. The measure contains provisions that override existing
sections of the California Constitution and other laws to the extent
that they are in conflict with this measure’s requirements. For example,
changes to current employee and related public employer pension
contributions are required to be put in place notwithstanding provisions
of existing contracts or the California Constitution’s Contract Clause.
Fiscal Effects
This complex measure would make changes to
hundreds of different public employee pension plans throughout the
state. It would almost certainly be subject to a wide array of legal
challenges pertaining to its changes to benefit plans that enroll
current and retired public employees, including, but not limited to,
suits alleging that the measure would impair public contract obligations
under the U.S. and/or California Constitutions. Moreover, the provisions
of this measure would be subject to considerable and potentially varying
interpretations by public employers and pension systems. In some cases,
provisions of the federal Internal Revenue Code—which governs the tax
status of public pension plans—may limit the flexibility of pension
systems to implement certain provisions of this measure. Given all of
these factors, there is large uncertainty about this measure’s possible
fiscal effects, which we attempt to describe below. There is also large
uncertainty about how this measure—applying broadly to nearly every type
of government worker—would apply to the variety of public employees in
California, which include teachers, public safety workers, office
workers, professors, and many others.
Impacts Related to Future Employees
Potentially Large Retirement
Benefit Savings Over the Long Term. Under the U.S. and
California Constitutions, public employers generally are free to alter
existing contractual obligations, such as those for pension benefits, as
applied to employees hired after the date of that alteration. This
measure’s limitations on future employees’ retirement benefits would
reduce governmental costs for those benefits substantially. Accordingly,
California public employers likely would be able to reduce their
retirement benefit costs by billions of dollars per year (in current
dollars) once public employees hired on or after July 1, 2013 constitute
the bulk of their workforces. This likely would not occur until several
decades from now.
Included in such cost savings are likely
reductions in public employers’ costs to provide health benefits to
retired future employees. While not affected specifically by this
measure, these retiree health benefits generally would cost less for
governments over the long term because future employees would likely
retire at later ages than current employees. Thus, governments would pay
for these benefits for fewer years, and under current federal law, the
Medicare program of the U.S. government would pay a greater share of
these benefits for future employees.
Offsetting Increases in Other
Compensation Costs. To ensure that total compensation for future
employees is competitive with that offered by other employers, many
public employers likely would increase pay, health benefits, or other
non-retirement benefits for future employees. This would partially
offset the retirement cost savings described above.
Impacts Related to Current Employees
It is unclear how exactly this measure’s at-risk
funding status evaluations would have to be conducted. We assume for
purposes of this analysis that most—perhaps all—California public
pension plans (which have significant unfunded liabilities under
existing accounting methods) would initially be at risk under the
definitions of this measure. Furthermore, we assume few public entities
would be able to appropriate enough money to immediately change their
plans’ status. As noted above, this could result in substantial changes
to employer and current employee contributions to pension plans so long
as the at-risk status persists.
Possible Significant Decrease in
Pension System Investment Returns. This measure would require
that certain pension system accounting calculations be based on
private-sector or ERISA standards, which may require systems to use
lower assumptions for future investment returns than they use today. In
general, when pension systems use such lower assumptions, their
estimated normal costs increase, as do estimates of their unfunded
liabilities.
This measure may not be construed to require that
pension systems use such private-sector accounting standards when
setting required employer and employee contribution rates for current
employees. Nevertheless, because this measure would require
future employees to earn
pension benefits that are substantially different from those now offered
to current employees, this could result in substantial changes to how
California’s pension systems invest or “pool” their pension funds. If,
for example, pension funds “close” their existing pension plans for
current and past public employees and deposit contributions related to
future public employees in separate pension funding pools, this could
result in lowered investment returns for the plans for a variety of
reasons and concomitant higher estimates of normal costs and unfunded
liabilities.
Even if funds do not close existing plans,
changes in their asset allocation to ensure they can meet existing
benefit obligations to current and past public employees also may result
in lowered investment returns. Public employers may, in some cases, be
able to shift some such higher costs, over time, to current employees
under this measure. This measure, however, would not require them to
shift all such higher costs
to their employees (nor, perhaps, would such a shift be found by courts
to be constitutional). Accordingly, in the short and medium term
(perhaps over the next two or three decades), these changes could result
in public employers having to contribute up to several billion dollars
more per year (in current dollars) to cover pension costs of current and
past employees.
Effects of Shift of Costs to
Current Employees. This measure contains provisions that seek to
shift pension costs from public employers to current employees over
time. For example, the measure contains limits on employer contributions
for normal costs related to current employees and allows shifts of
unfunded liability costs to employees in some cases. If able to be
implemented fully, these provisions could help reduce some public
employers’ annual pension costs during some periods in the coming few
decades. By shifting costs to current employees in this manner, some
public employers could encourage or induce employees to “opt out” of
existing pension plans and shift to the plans authorized for future
employees under this measure.
Other Potential Public Employer
Savings. For some current employees, this measure would provide
for lower pension benefit costs by requiring benefits to be based on the
highest three years’ average base pay—rather than existing benefit
provisions (often based on the highest single year’s pay). This measure
also would limit future cost-of-living increases for all current and
future retirees. If able to be implemented, these could reduce public
employers’ costs for current employee benefits during the next few
decades. The amount of this savings is unknown, but likely of a lower
magnitude than the other savings and cost issues described above.
Potential Public Employer Costs.
As with their costs to compensate future employees, public
employers likely would increase pay, health benefits, or other
non-retirement benefits for current employees to ensure their
competitiveness in the labor market.
It is unclear exactly how the measure’s
provisions for death and disability benefits would affect current
employees and their beneficiaries. To the extent that the measure
requires these benefits to be provided outside of existing retirement
systems and governments provide death and disability benefits similar to
those now in place, increased costs could result for some public
employers.
Conclusion
In the short and medium term (perhaps the next
two or three decades), the various financial effects of this measure
make its net fiscal effects for state and local employers difficult to
determine. During these decades, public employers may face significant
increased costs or some savings related principally to current and past
employees’ pension and other retirement benefits.
Over time, a greater portion of public employers’
personnel costs would be related to future employees—those hired on or
after July 1, 2013, and, therefore, subject to the most significant
benefit limitations under this measure. For these future employees,
governments would experience substantial savings in retirement costs.
These savings would be partially offset by higher costs for employee
salaries and non-retirement benefits in order to keep public-sector
compensation levels competitive in the labor market. Accordingly, when
costs for these future employees constitute the bulk of public
employers’ personnel costs—several decades from now—governments could
experience significant net savings.
Summary of Fiscal Effects
This measure would result in the following major
fiscal effects for state and local governments:
·
Over the next two or three decades,
potentially significant increased annual costs or some savings in state
and local government personnel costs, depending on how this measure is
interpreted and administered.
·
In the long run (several decades from
now), annual savings in state and local government personnel costs of
billions of dollars per year (in current dollars), offset to some extent
by increases in other employee compensation costs.
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