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Was PEPRA Enough?

Rick Roeder       February 2014

On September 12, 2012, the California Legislature passed a bill, “PEPRA,” which reduced pension accruals for new hires after January 1, 2013. The bill was a response to skyrocketing contributions which have handicapped many municipalities in their day–to–day operations. Impacted were state employees, PERS contract agencies and employees of the 20 County systems under the 1937 Act. PEPRA also included language in regard to “pensionable compensation” –– an attempt to curtail the pension spiking scandals that cast a blight on the pension environment.

PEPRA’s multiplier for Safety benefits became 2.7% at a higher Normal Retirement Age of 57. Thus, recent Safety hires, who elect to retire at age 50, will be strapped with a significant actuarial reduction in their pension. For General employees, the multiplier was 2.5%, but at a much higher Normal Retirement Age of 67. Historically, the average retirement age for General employees has been in the late 50s. If actual retirement ages remain relatively stable in the future, the actuarial reductions from Normal Retirement Age to actual retirement ages will be significant.

Despite PEPRA’s adoption, there continues to be movement for even larger changes in the state’s pension system. San Jose Mayor, Chuck Reed, has been spearheading the efforts of several cities to obtain contribution relief (The Mayors of San Bernardino, Anaheim and Pacific Grove are also on board). Reed’s mission is to garner enough signatures to put to a vote this November a state initiative to allow reduction in future accruals for current employees, as is possible in the private sector. Reed has been railing at the way Attorney General Kamala Harris has couched its current ballot measure language. Reed finds the first three words of Harris’ explanation of the potential ballot measure, “Eliminates constitutional protections,” to be extremely biased because no benefits accrued–to–date would be impaired. Harris would counter that current constitutional protections are for all potentially earnable benefits promised at date of hire, not solely benefits attributed to past service. Reed has expressed some doubt about the ability or desirability of getting the required 800,000 signatures by June 5 to put the measure on the November ballot, given Harris’ current ballot wording. Stay tuned as Reed plans to challenge the language in California’s Supreme Court. Reed has not been the Lone Ranger as other movements are also afoot at local levels to change the status quo.

Many actuarial rates have continued their unrelenting increases for a variety of reasons. PEPRA will have significant long–term effect but the accrued benefits for all retirees and active members as of January 1, 2013 were not impacted. Future accruals for all active employees as of December 31, 2012 are not impacted. A 25–year–old Safety hire in December 2012 can work for 25 years and still retire in 2037 with a 75% pension at age 50 if he had been eligible for a “3% at 5” formula at PEPRA’s effective date.

What cannot be debated is the level of actuarial rates are at unimaginable heights at the time significant benefit increases, conferred by Senate Bill 400, were ratified in 2000. Who would have thought system contribution rates, approaching or exceeding 30% of payroll, would no longer induce shock? There are four prime reasons for this ongoing upward trend in addition to the increased benefit multipliers.

• The recent vitality in the stock market from 2009–13 has not fully overcome the massive investment shortfalls occurring from 2001–08. In response, most systems have adjusted their investment return assumption downward, adding yet another element of contribution increase.

• Some of the actuarial estimates of the marked benefit increases have understated the change in retirement activity caused by the increase. For example, Dan Borenstein of the Contra Costa Times wrote a January 31 piece on how the accelerated incidence of retirement for CHP officers, after implementation of “3% at 50” was vastly understated for a number of years. Recently, CalPERS actuarial staff creditably made recent recommendations to better reflect current reality. Earlier retirements than anticipated mean more pension dollars leaving the trust than expected.

• The trend toward longer lifetimes continues unabated.

• Public sector employment has become significantly more attractive in the 21st Century due to more job security and much better benefits than the private sector. Fewer employees leaving their government jobs translates into more future pension payouts than actuarially predicted.

California’s systems have been riddled with multiple tiers of benefits over the past 35 years. Complicated! After Proposition 13 was passed in 1978, many County systems, facing the prospect of reduced property tax revenues, put in Tiers of reduced benefits for new hires. Actuarially, the impact of those reduced Tiers did not significantly impact contribution rates until 5–10 years after the change, largely because future accruals for active employees, at time of change, were not impacted. A new Tier only impacts recent hires, who have lower salaries and relatively little service credit.

We believe PEPRA was sound legislation which will still provide healthy pensions at a more affordable price in the long term. However, the shorter–term problem of current contribution levels will still painfully exist over the next decade. Whatever the short–term fixes, if any, prove to be, we recommend a continuance of some defined benefit structure – even if such structure is a hybrid with defined contribution elements. Introduction of a solo defined contribution plan for new hires, while a superficially attractive solution, puts future municipal employees more at risk than we view as ideal. If defined benefit plans do remain the staple, the public should be better protected by imposing very strict conditions prior to any future benefit increase.

For those advocates of defined contribution plans who point to the private sector and their overall lack of defined benefit coverage, our response is “two wrongs do not make a right.”

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