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CHAPTER 1
BACKGROUND
Collective Bargaining in the Public Sector
The Ralph C. Dills Act was enacted in 1977 “to promote full communication between
the State and its employees” and “to promote the improvement of personnel management and
employer-employee relations.” It outlines a State employee’s right to join and be represented
by a designated employee organization and grants a designated employee organization with
the exclusive right to negotiate employment issues with the State on behalf of State
employees. The State, represented by the Department of Personnel Administration (now
called California Human Resources) and the designated State Employee Union, must “meet
and confer in good faith” to reach an agreement regarding State employee “wages, hours, and
other terms and conditions of employment.” Once an agreement is reached, both parties
jointly prepare a written memorandum of understanding (MOU) that becomes effective once it
is ratified by the Legislature. This MOU will outline, amongst other things, the retirement
benefits available to the all employees covered under the MOU. The California Public
Employees Retirement System administers these retirement benefits. (Dills Act)
California Public Employees Retirement Systems
The State Constitution and statutes authorize the establishment of systems to provide
pension and other benefits to current and retired public employees. Approximately four
million Californians, 11 percent of the population, participate in one of the 85 public pension
systems in California, one million of whom currently receive benefits. (LAO Niello Initiative
Analysis) The largest pension system in California is the California Public Employees
Retirement System (CalPERS), which administers the health and retirement benefits for State
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employees and employees of more than 3,033 contracting local government agencies and
school districts.
As of June 2010, CalPERS had 1,629,667 members, 513,623 of whom are retirees,
beneficiaries, and survivors receiving a monthly allowance. Approximately 31 percent of these
are employed by the state and have their employer contribution for retirement benefits paid by
the State (CalPERS Facts at a Glance). In theory, these employer contributions combined
with the employees’ contribution and investment returns will yield sufficient assets to pay
benefits at retirement. However, in reality, numerous variables can impact the fund’s
solvency. These are discussed in the sections below.
While CalPERS expects an average annual investment return of 7.75%, in fiscal year
ending on June 30, 2007, the fund earned 19.1% return. This marked the fourth year CalPERS
maintained double-digit returns and concluded a 10-year average of 9.1% where CalPERS
consistently exceeded industry benchmarks in many of its asset classes. (CalPERS)
After more than a decade of strong investment returns, in 2008, CalPERS lost $70
billion of assets—from $2.553 billion on January 1, 2008 to slightly under $183 billion on
December 31, 2008. (CalPERS, 2009, Pew Center on the States, 2010). The other major
pension systems in California experienced similar losses during this time. Between June 2008
and June 2009, California Public Employees Retirement System (CalPERS), California State
Teachers Retirement System (CalSTRS), and University of California Retirement System
(UCRS), who together administer the pensions of approximately 2.6 million Californians lost
a combined $109.7 billion in their portfolio value (SIEPR Bronstein et al).
This decrease occurred when California's budget deficit grew to more than $60 billion
and California’s unemployment rate grew from approximately six percent to more than 12
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percent as a result of the meltdown of the state and national economies (Bureau of Labor
Statistics, 2011, Halper & Goldmacher, 2010). This systemic economic meltdown sets the
stage for the current pension debate in California that will ultimately impact the State
employee retirement benefits discussed in the next section.
State Employee Retirement Benefits
Retirement benefits vary substantially among public agencies; however, most
employees of the state and contracting agencies are eligible to receive a pension. A pension is
a defined benefit plan that provides a lifetime annuity after retirement that is based on a
predetermined retirement formula that takes into account the age at retirement, number of
years of employment, final compensation (average highest salary over a specified amount of
time), classification (type of work), and a predetermined retirement multiplier (expressed as a
percentage of highest average salary). The benefit factor and the minimum retirement age are
the most important components of the retirement formula as they most significantly affect the
annual retirement benefit (CalPERS).
Employees are able to retire without penalty once they reach the minimum age, but
some classifications can retire earlier with a reduced benefit factor or earn a higher benefit by
working past the specified retirement age. An employee’s annual retirement annuity payment
is calculated by multiplying the number of years worked by the retirement factor that is then
multiplied by the employee’s highest salary (for one to three years as determined by the MOU
under which the employee was hired). For example, an employee with a two percent at 60
formula, who worked for 25 years and whose highest annual salary was $50,000 would
receive an annual retirement benefit of $25,000 assuming retirement at age 60. (e.g. 25 years
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multiplied by two multiplied by $50,000 equals $25,000). This benefit is paid in monthly
installments, which are adjusted annually to account for cost of living increases. (CalPERS)
Pension benefits are funded through a combination of employee and employer
contributions, combined with future investment returns, which, as stated above, should yield
sufficient assets to cover future retirement obligations. Employee contributions are dictated
by a combination of statute, collectively bargained MOUs, or through a contract with an
employee and can only be changed by law or the MOU under which the employee works.
(LAO, 2010, Pension Reform Analysis, Betts v. Board of Administration) Currently, State
employees pay between eight and 11 percent of their income for retirement benefits.
(CalPERS)
Unlike employee contributions, employer contributions are adjusted annually, based
on actuarial estimates, to provide the remaining funds required to ensure current assets are
sufficient to pay future pension liabilities. These estimates consider current assets, market
fluctuations, and estimated pension liabilities based on average retirement age and life
expectancy amongst other determinants. Essentially, actuaries determine the total contribution
required to provide current assets necessary to yield earnings that cover future pension
obligations; employees pay the amount outlined in their MOU and the employer, in this case
the State, pays the remainder. Currently, the State’s employer contribution is between 19 and
32 percent of an employee’s annual income depending upon the employees MOU; however,
due to the unpredictable and varied nature of the market and other determinants, the employer
contribution can vary wildly from year to year, with lows of zero percent and highs of more
than 34 percent. (CalPERS Annual Report, LAO 2004) These wild fluctuations have made it
difficult for the State to make long-term retirement cost projections and have contributed to
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the budget instability considered to be a primary cause of California’s pension situation.
Moreover, this instability and inability to make long-term projections undermines any
strategic planning efforts, as the assumptions on which efforts are based are often incorrect.
Like employee contribution rates, employee retirement benefits vary based on work
classification and bargaining unit. State employees fall into one of three work classifications:
Miscellaneous/Industrial (clerical, administrative, and industrial staff), State Safety (Fish and
Game Wardens, Public Safety Dispatchers, etc.) and Peace Officers/Firefighters (Highway
Patrol Officers, Firefighters, and Prison Guards). (CalPERS, 2007) Bargaining units are
subsets of these classifications and are covered under the provisions of their respective MOUs.
While one employee organization may negotiate on behalf of numerous bargaining units in
various classifications, each bargaining unit is represented exclusively by one employee union
and subject to only one MOU. Despite the difference in pension formulas, employee
contribution rates, and other benefits, benefit enhancements and decreases generally occur
across the board and directly correlate with the economy. These benefit changes will be
discussed in detail in the next section.
History of State Employee Retirement Benefits
There have been three major modern-day changes to state employee retirement
formulas and two alternative retirement plans offered. Prior to the passage of SB 400, the
landmark state pension legislation passed in 1999, the benefit formulas for the three
classifications were as follows: Miscellaneous/Industrial 2% at 60, State Safety 2% at 55, and
Peace Officer/Firefighter 2% at 50. (Chapter 555, California Secretary of State, 1999)
Miscellaneous/Industrial employees could retire as early as age 50 with a reduced retirement
factor and could earn a benefit up to 2.4% at age 60.
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Until 1990, an average of the highest consecutive three-years was used to calculate the
final compensation on which the retirement benefit was based; however, in 1990, as part of a
budget compromise with various labor unions, the legislature approved SB 2465, which
changed the final compensation from a three-year average to only consider the highest oneyear salary. (Chapter 1251, California Secretary of State, 1990; Summers, 2010; Hill &
Korber, 2004) This change proved to be much more costly than originally anticipated. While
the Department of Finance estimated an annual cost of $69 million per year, by 2004 it had
cost the state $100 million per year. The primary reason for the increased expense is the
unintended consequence of the shorter final compensation period—a practice known as
“pension spiking.” Pension spiking occurs when an employee (generally a highly paid and
well-connected employee) is afforded a large salary increase shortly before retirement or is
allowed to use non-salary benefits such as sick leave and vacation in the final compensation
calculation. This provides a dramatically higher post-retirement salary for the employee than
would have otherwise been earned, and by extension, requires a considerably higher
retirement expenditure for the state than would reasonably have been expected. This practice
can cost the state hundreds of thousands of dollars for an individual employee and collectively
costs the state millions per year.
In 1984, an alternative retirement tier, known as Tier 2, was created to reduce the
state’s cost for retirement benefits. Tier 2 provided 1.25 percent at 65 and required no
employee contribution. In theory, the significantly lower benefit factor and increased
retirement age would yield a lower retirement benefit and reduce the number of years an
employee would receive a retirement benefit which would reduce the state cost for benefits
and offset the lack of employee contributions.
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At its inception, 47 percent of employees opted into Tier 2. By 1991 enrollment into
Tier 2 became mandatory for all new state employees. However, mandatory enrollment was
repealed in 1999 with the passage of SB 400 (Little Hoover) because cost analyses indicated
that, despite the substantially lower retirement benefit, the employer contribution rate was
lowered by less than 1 percent, and therefore, did not realize the expected savings and could
yield insufficient retirement savings for participants. (CalPERS)
SB 400, which was enacted in 2000, substantially improved state workers’ benefits. It
was sponsored by CalPERS to resolve inequities between various classes of membership
within CalPERS and to allow CalPERS members to benefit from a decade of strong market
returns that resulted in annual reductions to employer contributions, but had not similarly
benefitted CalPERS members. SB 400 reduced the minimum retirement age for
miscellaneous and industrial employees by five years (from 60 to 55), increased State Safety
employees from two percent to two and a half percent, and increased the benefit factor for
Peace Officers and Firefighters from two percent to three percent. (CalPERS, 1999) These
benefit improvements were applied to all past and future service. It also closed the inferior
Tier 2 retirement plan to new members and allowed existing members in Tier 2 to switch all
prior and future service to Tier 1. This provided a dramatic increase in retirement benefits for
state employees (up to 50 percent for some employees) and increased retirement obligations
for the state upon enactment. (Summers)
CalPERS intended to fund the benefit enhancement through assets generated due to
the superior performance of the stock market over the previous several years and an
accounting change that would increase the value of assets in the fund and was not expected
increase the state’s cost for retirement benefits. (SB 400 Analysis) This proved to be a gross
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underestimate of costs or, at the very least, did not consider the potential impacts of a future
market downturn, and has resulted in hundreds of millions of dollars in state expenditures for
state employee retirement benefits. (Summers) Many pension reform proponents argue that
this piece of legislation is a primary cause of the current pension crisis and its components
should be repealed, and in many cases, should be prohibited in the future.
In an attempt to reduce the States cost for employee retirement benefits, in 2004, the
state introduced the Alternate Retirement Program (ARP). ARP is a DPA-administered
retirement savings plan that all new, first-time State Miscellaneous and Industrial employees
are automatically enrolled into for the first two years of employment in lieu of the CalPERSadministered pension plan. New employees have approximately five percent of their salary
automatically deducted as a pretax contribution to fund the account. The State, however, does
not make any contributions to this account and employees do not earn service credit (years
used in the retirement formula to determine retirement benefit) during this time. After two
years of employment, employees are automatically enrolled into the CalPERS-administered
pension. Once enrolled, the State begins to contribute to employee pensions and employees
begin earning service credit. After four years of employment, employees can roll ARP
contributions into the System and earn the two years of CalPERS service credit they would
have earned had they become a member of CalPERS upon hire. Employees who choose not
use these funds to buy service credit have their retirement savings transferred to a DPAadministered 401(k) retirement plan.
ARP reduced the State’s contribution to employee retirement and eliminated it for
short-term employees. It also encouraged many employees to work longer to meet minimum
vesting requirements for other post-retirement benefits. While the implementation of ARP
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yielded retirement cost savings for the State, the savings proved insufficient to maintain the
solvency of the retirement fund after the economic downturn.
In attempt to appease pension reformers and avoid mandated cuts to current retirement
benefits, the Unions agreed to benefit reductions and employee contribution increases in the
2010 Memorandum of Understanding negotiations. As a result, new employees hired on or
after January 1, 2010 are subject to pre-SB 400 retirement formulas and a final compensation
calculation based on the average of the highest three years of employment. Retirement
contributions for current and new employees were also increased by three to five percent.
Some of the Safety and Peace Officer/Firefighter bargaining units who were only subject to
higher employee contribution increases were excluded from the formula changes. (CalPERS
site, MOUs) The changes to retirement benefits are summarized in the chart below.
Table 1: State Employee Retirement Formulas
Retirement Category
Pre-SB 400
Formula
Post-SB 400
Formula
2010 MOU
Formula
Miscellaneous/Industrial
2% at 60
2% at 55
2% at 60
State Safety
2% at 55
2.5% at 55
2% at 55
Peace Officer/
Firefighter/CHP
2% at 50
3% at 50
3% at 55
Source: SB 400, CalPERS website
While the reforms discussed above attempted to undo the damage caused by the passage
of SB 400, none have come close to resolving the multifaceted pension reform predicament
that involves quantifiable financial and actuarial estimates in addition to less measurable
aspects such as societal perceptions of state worker benefits, political platforms, and impact of
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reform on hiring and retaining qualified employees to ensure proper functioning of the state.
The next chapter will discuss these issues in depth.
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CHAPTER 2
UNDERLYING ISSUES WITH STATE EMPLOYEE PENSION REFORM
To understand which pension reform measures will most effectively resolve the current
pension debate, it is important to understand the underlying issues that resulted in the need for
reform and that must be resolved to maintain collective bargaining as the primary process
through which retirement benefits are determined and avoid state- or voter-mandated reform.
The current pension reform debate is based on the following three issues, which will be
discussed at length below: high unfunded liabilities, the high and unpredictable cost to the
State and taxpayers for State employee retirement benefits, and the negative public sentiment
regarding public employee benefits. While many of these can only be resolved through
processes outside the scope of collective bargaining, to maintain collective bargaining as the
primary process for determining state employee retirement benefits, these union must address
these either though support of alternative proposals to mitigate the problem or through
concessions made in the collective bargaining process.
Unfunded Liabilities
An unfunded liability exists when the predicted cost of future pension liabilities
exceed the future assets in the pension fund based on actuarial assumptions. Because State
employee pension benefits are considered a form of deferred compensation, they are protected
by United States and California Constitutions contract clauses and must be paid upon
retirement regardless of whether pension fund assets are sufficient to pay benefits to retirees.
(Article I Section 10 of the United States Constitution, & Article I Section 9 of the
Constitution of the State of California) The California Supreme Court outlined this obligation
to pay retirement benefits in the Betts v. Board of Administration decision in 1978.
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“A public employee’s pension constitutes an element of compensation, and a
vested contractual right to pension benefits accrues upon acceptance of
employment. Such a pension right may not be destroyed, once vested without
impairing a contractual obligation of the employing public entities.” (Betts v.
Board of Administration, 1978)
In other words, if the pension fund does not have sufficient assets to pay benefits at
retirement, the state’s General Fund, which is funded through tax revenue, must pay the
difference. This gives State employee retirement obligations priority over all other General
Fund expenditures. In a good economy when state coffers are sufficient and retirement funds
are solvent, this implies a minimal risk; however, during an economic downturn, similar to the
current situation, both the state and the pension funds are ill-equipped to pay this obligation.
Economic downturns generally correlate directly with state budget deficit increases and
pension fund asset losses, placing state employee retirement benefits in direct competition
with many critical public services including schools, law enforcement, and safety net
programs that also come from the General Fund.
While 100 percent funding or more is ideal, the United States Government
Accountability Office advises that states have at least an 80 percent funding level to ensure
that retirement funds have sufficient assets to cover retirement obligations. (The Widening
GAP) As of 2010, California pension systems were 81% funded (Widening Gap); however,
CalPERS was only 61% funded. (Little Hoover Commission) While estimates of CalPERS
actual unfunded liabilities vary dramatically—from CalPERS report of $35 billion to Stanford
University’s report of $240 billion—it is clear that current unfunded liabilities could result in
costs to California taxpayers that could be difficult to mitigate without dramatic action.
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(CalPERS, 2009; Bornstein 2010) This sentiment is confirmed by CalPERS Chief Actuary
Ron Seeling’s statement that current benefit levels are “unsustainable.” (Calapensions)
Based on current unfunded liabilities and recent losses, estimates suggest that it would
take 30 years for California to fully fund the pensions system and, after considering the asset
losses in 2009, would require investment returns exceeding 20 percent per year if no changes
are made to the current system. (Buck, 2010) CalPERS investment returns have only
exceeded 20 percent one time in the past 10 year suggesting that this scenario is unlikely,
especially when considering the current market returns.
Unfunded liabilities can result from a variety of issues, but generally fall into one of
three categories: actuarial policies, investment policies, and benefits policies. Inaccurate
actuarial assumptions can lead to insufficient contributions to the pension fund which yield
less investment returns that compound over time to leave the fund without assets to pay
pension liabilities. Actuarial assumptions are based in part on projected market returns,
making poor or risky investment policies more damaging. In addition to skewing actuarial
assumptions and yielding investment returns substantially lower than projected, unsound
investment policies can result in dramatic asset losses and leave the fund more susceptible to
market downturns (SIEPR, Bronstein et al). Both actuarial and investment policies are outside
the scope of collective bargaining; however, based on current statute, benefit policy should be
changed through the collective bargaining process. Unlike actuarial and investment policies,
which affects how assets are put into the fund and managed, benefit policies determine how
much will be paid out in retirement benefits and at what age benefits will be available.
Specific impacts of changes to benefit policies and potential changes that can be negotiated
will be discussed in the next chapter.
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Cost to Government/Taxpayers
The state, and consequently taxpayers, can pay for pension benefits in two ways:
employer contributions paid toward state employees’ retirement plans while they are working
and, in the event of a default, for retirement benefits not sufficiently funded by the retirement
fund assets at the time an employee retires. The former is primarily a function of benefit
policy. While the latter is more easily avoided through actuarial and investment policies, it
could be impacted by benefit policies. Improved actuarial policies and investment policies
would stabilize annual fluctuations and reduce the likelihood of future unfunded liabilities,
which would likely reduce the state’s cost for employee retirement benefits and allow for
better long-term planning. Similarly, changes to benefit policies that reduce the benefit paid at
retirement, increase an employee’s total contribution to retirement, or reduce the number of
years an employee receives retirement benefits reduce the state’s cost for retirement benefits
and the likelihood of an unfunded liability.
Although benefit policy is the only policy type this paper is concerned with, it
assumes change to all three are necessary to address the systemic issues with California’s
pension system that have rendered it unsustainable. Under the current system, the state has
had high and unpredictable employer contribution costs that have been exacerbated by a 30year unfunded liability (Bornstein et al., 2010 & CalPERS, 2009). As a result, it has been
difficult, if not impossible, for the State to make long-term retirement cost projections and,
consequently, challenging to properly fund the Retirement Fund. This inability to maintain a
stable and solvent retirement fund, coupled with the threat of increased costs for taxpayers to
pay for benefits far superior to the average employee in California has lead to an increasingly
negative public sentiment towards state workers’ benefits.
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Public Sentiment
While there is widespread disagreement about whether the public’s issue with state
employee benefits is simply “pension envy” or genuine concern about the State’s, and
consequently taxpayer’s, current or potential costs for state employee retirement benefits, one
thing is clear: the public is becoming less supportive of State employee pensions. High
unemployment rates, inferior private sector benefits, and highly publicized incidences of
pension fraud and six figure annual retirement payouts are creating an increasingly negative
public opinion of public employee pensions.
A recent PPIC poll “Californians and their Government” indicates that 67 percent of
the Californians polled would favor “changing the pension systems for new public employees
from defined benefit to a defined contribution” and that 41 percent believe that the “amount of
money being spent on their public employee pensions and retirement systems” is a big
problem. (Another 35 percent believe it is “somewhat of a problem”). This represents an
increase of six percent in favor of switching to a defined benefit plan and 10 percent increase
in people believing pension expenditures are a big problem from the 2005 poll. (PPIC)
Furthermore, recent elections (November 2010-June 2012) suggest that if placed on the
ballot, voters may support substantial decreases to public employee benefits including the
elimination of pensions entirely. Eighteen of the 20 pension reform ballot initiatives
introduced since 2010 have passed. (CFFR) Of the 10 local pension reform ballot measures
that were introduced during the November 2010 election, and all but one passed and, more
recently, in June 2012, both San Jose and San Diego voters overwhelmingly supported
dramatic changes to their local Retirement Systems. The San Diego initiative will freeze
employees base salary for the next six years, eliminate pension spiking, and put all new hires
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except for police officers into 401-k type retirement plan. Current employees of the city of
San Jose will now have to pay up to 16 percent of their salary to maintain current benefits or
opt for inferior benefits. New employees will not have the option of paying for superior
benefit. (Washington Times)
This section discussed the underlying issues that pension reform is intended to address
and that the any successful collectively bargained resolution must address. While this paper is
specifically focused on how pension reform can be effectively resolved through collective
bargaining, it is important to understand the other entities that have the power to mandate or
influence pension reform. The next chapter discusses these entities, their legal authority, and
their recent history of influencing public employee pension benefits.
Legal Authority to Alter Public Employee Benefits
The introduction briefly discussed the Dills Act, which authorizes Unions and the
Governor, represented by DPA, to negotiate issues related to state employee wages, benefits,
and other employee-employer relations issues. While pension benefits, under Dills, are
supposed to be decided through the collective bargaining process, federal and state laws
outline the powers of various entities to change state employee benefits. This section will
briefly discuss the state and federal laws related to pension benefits and the legal authority
they provide to the Legislative, Judicial, Executive branches as well as the powers afforded to
California voters.
The State and Federal Constitution and California statute include numerous provisions
outlining various legal aspects of state employee retirement benefits. Article I, Section 10 of
the U.S. Constitution prohibits any state from passing any “law impairing the obligation of
contracts.” The California Constitution similarly includes language preventing the Legislature
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from passing any law impairing the obligation of contracts. As discussed above, the courts
have generally held that these “contract clauses” prevent the government from altering or
reducing state employees pensions because they constitute “an element of compensations” and
“may not destroyed without impairing a contractual obligation of the employing entity.”
(Betts vs. Board of Education 1978). The courts, however, have allowed for modifications for
current and past employees when the reductions were offset with a comparable advantage, and
have upheld the State’s right to change pension benefits for future employees prospectively
through the collective bargaining process outlined in the Dills Act.
The Dills Act, amongst other things, outlines the State employees’ right to join Unions
as well as the unions’ right to negotiate on behalf of State employees. Per the Dills Act,
public employees “have the right to form, join, and participate in the activities of employee
organizations of their own choosing for the purpose of representation on all matters of
employer-employee relations” and also “have the right to refuse to join or participate in the
activities of employee organizations...” While employees have the right to refuse
membership, the Dills Act outlines an “agency shop...which is an arrangement that requires an
employee, as a condition of continued employment, either to join the recognized employee
organization or to pay the organization a service fee in an amount not to exceed the standard
initiation fee, periodic dues, and general assessments of the organization.” (Dills Act) In other
words, employees must pay a “fair share” to the Union regardless of membership to offset the
costs of shared benefits resulting from Union negotiations.
Similarly, the Dills Act outlines that the unions have the exclusive right to represent
employees on “all matters relating to employment conditions and employer-employee
relations, including, but not limited to, wages, hours, and other terms and conditions of
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employment...excluding the consideration of the merits, necessity, or organization of any
service or activity provided by law or executive order.” It also outlines that the Governor or
his or her designated representatives represent the State “for the purposes of bargaining or
meeting and conferring in good faith.” (Dills Act) The Department of Personnel
Administration is the designated representative for the Governor in these negotiations.
While the Unions and DPA negotiate all employee-employer relations issues and
reach an agreement that is outlined in a memorandum of understanding, the Dills Act requires
that the Legislature ratify all MOU’s before they are enacted into law. This suggests that any
agreements reached between DPA and Unions must have support from the Legislature to
become effective. In addition to MOU ratification, the legislature can also introduce
legislation to amend retirement benefits. The Legislature has a long-standing history of
reforming pension and other state employee benefits, the most notable of which, SB 400, was
discussed above.
Historically, the California Legislature as a whole has not supported proposals that
decrease pension benefits; however, the current state of the economy and political climate
have created an environment where benefit reductions have more support than previous years.
This year alone, several bills have been introduced by legislature to make a variety of changes
to retirement benefits, many of which were introduced to implement measures in the
Governor’s Pension Reform proposal. (Governors 12 Point Pension Reform Proposal). While
the Legislature may introduce proposals independent of the Governor’s wishes, any legislative
proposal that is passed by the legislature must also be signed by the Governor to be enacted
into law, and therefore, at the very least, must have the Governor’s support. This relationship
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suggests some of the ways the Governor can influence changes to state employee benefits
outside of the collective bargaining process.
In addition to the power to veto legislations, the Governor also heads the Executive
branch, which includes all of the state agencies, commissions, and boards—most relevantly
CalPERS, the agency that administers the state employee retirement plans, and DPA, the
agency that negotiates state employee benefits on behalf of the government. Combined these
entities can have a considerable amount of power over state employee benefits. As discussed
above, the Governor can implement his or her agenda through the Legislative process or, as
the legally authorized representative of the state in negotiations, through DPA in the collective
bargaining negotiations. The Governor also has the power of Executive Order to exert
pressure or mandate policy change as Governor Schwarzenegger did with Executive Order S16-08 in 2008 when he mandated furloughs and approximately a 15 percent pay cut for all
state employees. While this did not directly affect state employee retirement benefits, it did
reduce their take-home salary and encourage Unions to negotiate benefit reductions in order to
end the furloughs, which were very unpopular amongst impacted employees.
While both legislative representatives and the Governor have the power to influence
public employee pensions, because each is elected by the voters, the policies they support or
oppose must be responsive to public sentiment. Because of the nature of elected positions,
voters can use a variety of means to directly and indirectly influence policymakers’ decisions
including requesting and lobbying on legislation, letter writing campaigns or protests, or
simply by making their beliefs known like in the PPIC survey discussed above. In addition to
the ability to influence legislative proposal and votes, California voters (and organizations)
can create policy change through the Initiative Process (California Constitution Article 2
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Section 8(a). This process allows any voter to place a proposal on the ballot if he or she
secures the legally required number of signatures (a percentage of the votes cast in the
previous gubernatorial election previous election count). While numerous statewide pension
reform proposals have been submitted to the Secretary of State for inclusion on the ballot, few
have secured enough signatures to be included.
The entities discussed so far have the power to exert pressure or mandate reform by
creating policy; the Judicial branch, though not having the legal authority to create policy, can
influence current and future policy through the interpretive powers vested in the courts. Any
policy changes enacted by through the Legislature, Executive Branch, or voters are subject to
interpretation by the courts. The Courts determine the intended meaning or legality of enacted
laws as well as adjudicate any lawsuits resulting from enacted laws.
As indicated above, the courts’ decisions have historically set precedent on which
benefits can be altered and have also determined the scope of power legally provided to the
Legislature, the Governor, and voters. While they have generally favored protection of
retirement benefits, recent lawsuits have allowed for reductions in salaries, mandated
furloughs, and other reductions to state employees’ compensation not protected under the
contract clauses in the state and federal Constitutions. These decisions provide important
leverage to the Governor and Legislature because, while they cannot reduce retirement
benefits for current employees, they can reduce total compensation, which has a much more
immediate impact on employees, and encourage the Unions to address concerns through
concessions in the collective bargaining process.
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While officially, the Unions and the DPA (on behalf of the Governor) negotiate state
employees’ benefits, numerous entities are have official or unofficial means of influencing or
altering state employee pension benefits.
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CHAPTER 3
CURRENT PUBLIC EMPLOYEE PENSION REFORM PROPOSALS
Several proposals have been submitted through a variety of entities to curb public
employee pension costs. This section will discuss the three most notable proposals: The
Public Employees Reform Act of 2011, The Little Hoover Commission’s pension reform
proposal, and the Governors Pension Reform Plan.
The Public Pension Reform Act of 2011
The Public Pension Reform Act of 2011 was a Constitutional Amendment Initiative
introduced through the ballot initiative process by former legislator Roger Niello. It was one
of several proposals submitted to the Secretary of State for inclusion on the 2012 ballot.
While none secured the necessary number of signature required to be included on the ballot,
this was considered a frontrunner and proposed the most dramatic change. Ballot Initiative
proposals amending state worker benefits have been introduced throughout the years, but have
rarely secured the necessary amount of signatures to be placed on the ballot. While this
proposal succumbed to the same fate, the decline in public support for state worker benefits
suggests that a proposal to reduce benefits could have passed, if placed on the ballot.
This proposal would have increased the retirement age to 62 for all employees,
required five years of full-time service for one or more public agencies prior to earning
retirement benefits, required that employee contributions be at least equal to the employer
contribution, and limited retirement benefits to no more than sixty percent (60%) of the
highest annual average base wage over a period of three consecutive years of employment. It
would have also provided public agencies with the exclusive authority to modify the terms of
23
pensions, retiree health, or other retirement benefits, and prohibited retroactive increases in
pension benefits. (Public Employee Reform Act)
Public Pensions for Retirement Security Proposal
The Little Hoover Commission, an independent California State oversight agency, in
its report Public Pensions for Retirement Security, makes several recommendations for
curbing the state’s pension costs. Like the Pension Reform Act, the Commission recommends
that the Legislature give state and local governments the authority to alter the future,
unaccrued retirement benefits for current public employees and place a cap on retirement
benefits or the salary used to determine benefits. It also recommends that the State discourage
productive and valuable employees from retiring early be setting “an appropriate retirement
age” though it does not specify an appropriate age. To help prevent pension spiking, the
proposal eliminates the purchase of “air time” and supports setting a tight definition of final
compensation that excludes all sources of income other than base pay and uses a five-year
average. Like the Act, it also prohibits retroactive pension increases and requires that
employee contributions equal employer contributions to retirement. While having many
similarities to the Act, Little Hoover further recommends that the state implement a hybrid
retirement plan that maintains the defined-benefit formula – but at a lower level – and
provides an employer-matched 401(k)-style defined-contribution plan that is risk-managed to
provide retirement security and minimize investment volatility. It also proposes that all
pension increases be submitted to voters accompanied by sound actuarial information, written
in a clear and concise format. (Little Hoover Report 2011)
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Governor Brown’s Pension Reform Plan
Governor Jerry Brown expanded on the 12 Point Pension Reform Plan he campaigned
with in his pension reform proposal released in late October 2011. He estimates that his plan
would save the state $4 billion to $11 billion over 30 years. (Ortiz 2010). This plan includes
several components that are also included in the Pension Reform Act and Hoover Commission
plans. Like the Commission, Brown’s proposal includes a “hybrid plan” that incorporates
both a pension and 401(k) for all new state employees. Like both of the previously discussed
plans, this plan would increase the full retirement age for new employees, but provides the
most dramatic increase to age 67. It also aims to reduce pension spiking by eliminating the
purchase of “air time,” excluding all sources of income other than base pay for use in the final
compensation calculation, and using the average of the highest three years of salary. Brown’s
proposal similarly requires employee contributions for retirement to match employer
contributions and prohibits retroactive pension increases.
These pension reform plans suggests widespread support for many pension plan changes that
should be the focus of negotiation attempts. All three proposals require that employee
contributions equal employer contributions for retirement. They also increase the full
retirement age, prohibit retroactive benefit increases and the purchase of airtime, and change
the final compensation calculation in a manner that would likely yield a lower retirement
benefit. There is also support for limiting post-retirement employment, placing caps on
retirement benefits, and revoking pension benefits for employees who are convicted of a
work-related crime. The chart below outlines the changes each proposal would implement if
enacted.
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Table 2. Provisions of Pension Reform Proposals
Public Employees
Pension Reform Act
Little Hoover Pension
Plan
Governors Pension
Plan
Employee/employer Requires that
contributions
employee contribution
be at least equal to the
employer
contribution.
Employee and
employer pension
contributions are
adjusted annually
based on an equal
sharing of the normal
costs of the plan.
Requires that
employee contribution
be at least equal to the
employer
contribution.
Benefit Increases
- Provides public
agencies with the
exclusive authority
to modify the terms
of pensions, retiree
health, or other
retirement benefits
provided to its
employees.
- Prohibits retroactive
increases.
- Gives state and local Prohibits retroactive
governments the
increases.
authority to alter the
future, unaccrued
retirement benefits.
- Prohibits retroactive
increases.
- All proposed
pension increases
must be submitted to
voters in their
respective
jurisdictions.
Air-time purchases
Eliminates air-time
purchases.
Eliminates air-time
purchases.
Eliminates air-time
purchases.
Retirement Plan
Type
Defined contribution
Hybrid plan
Hybrid plan
Caps on Benefits
Limits retirement
benefits to no more
than sixty percent
(60%) of final
compensation.
Cap on retirement
benefit or salary used
to determine benefit.
None
26
Public Employees
Pension Reform Act
Little Hoover Pension
Plan
Governors Pension
Plan
Final Compensation - Excludes all income
Calculation
other than base pay
from final
compensation
calculation.
- Requires final
compensation be
based on the highest
average of three
consecutive years.
- Excludes all income
other than base pay
from final
compensation
calculation.
- Requires final
compensation be
based on the highest
average of five
consecutive years.
- Excludes all income
other than base pay
from final
compensation
calculation.
- Requires final
compensation be
based on the highest
average of three
consecutive years.
Years of
Service/Retirement
Age
- Increases to age 62.
- Requires five years
of full-time service
prior to earning
retirement benefits.
Set at an “appropriate
age” to discourage
early retirement of
productive and
valuable employees.
Increases to age 67.
Miscellaneous
None
- Limits postretirement
employment.
- Revokes or reduces
pensions for
convictions
involving the public
trust.
- Limits postretirement
employment.
- Revokes or reduces
pensions for
convictions
involving the public
trust.
While state employee retirement negotiations are between the Department of
Personnel Administration and the various state employees unions, numerous stakeholders and
interests are represented by these negotiating parties. This section will discuss the conflicting
interests of both DPA and the Unions in their role in collective bargaining negotiations.
DPA negotiates with state employee unions on behalf of the Governor, the State, and
the taxpayers and in this capacity represents a variety of disparate interests. As the legal
representative of the Governor, DPA’s negotiating position would clearly align with Governor
Brown’s pension reform strategy aimed at cutting pension costs. However, while DPA’s
27
primary interest in this particular round of negotiations is reducing the State’s costs for
retirement benefits, it must also consider negative consequences to the State that result from
cost-cutting reform measures. As a representative of the State as an employer, the ability to
recruit and retain qualified employees remains a priority. Any reform measures that reduce
pension benefits may need to be offset by increases in other forms of compensation for the
State to remain competitive in the labor market, especially once the economy improves.
Furthermore, underqualified or demoralized employees can also lead to costly losses in
productivity. Similarly, as a representative of the Executive Branch, DPA must also consider
the impacts and cost of implementing any change to the pension system. Any savings
resulting from pension reform measures that are costly or difficult to implement, undermine
any savings. DPA, in its negotiating capacity, must weigh the savings and other benefits
resulting from pension reform with the potential costs resulting from loss of productivity,
increases to other form of compensation, or the implementation of changes. These
considerations present the Unions with their greatest bargaining strengths.
The Unions have similarly conflicting roles. State employee unions exist for the
purpose of protecting current and future state employees’ interests, specifically maintaining
union jobs and improving employee wages, benefits, and working conditions. While their
stated stance is to continually improve wages, benefits, and working conditions, they must
also be mindful of how unsustainable benefit levels can impact future employment and how
legal treatment of current and future employees can lead to inequitable treatment within Union
membership. For example, unsustainable benefit levels for current employees can lead to layoffs, furloughs, or dramatic decreases in benefits for current and future state employees, all of
which may in turn jeopardize Union support from current and future employees. Similarly,
28
since it is difficult to change current employees’ benefit levels, future state employees bear the
expense of current employees’ unsustainable benefits, but earn substantially inferior benefits.
As a representative of both current and future employees, the Unions must consider the
impacts of negotiated reform measures on both populations. Furthermore, it must evaluate
both the immediate and long-terms impacts of any reform in addition to any unintended
consequences.
In the current environment, the Unions’ primary focus must be on maintaining
collective bargaining as the central process for determining benefits because without collective
bargaining the Unions would be obsolete. To maintain collective bargaining, they must focus
providing cuts deep enough to create a sustainable system (as perceived by the Governor and
pension reformers) while mitigating the impacts of impending benefit reductions and reducing
the number of layoffs. Despite recently negotiated increases in employee contributions and
reductions in benefits for new employees in addition to other concessions, numerous state
employee pension reform proposals are being introduced, making it apparent that further
concessions will be necessary to maintain control of the decision-making process.
In the current environment, the factors external to the Unions that may determine
pension reform like the various pension reform proposals place the Unions in a less than
favorable bargaining position. They have few bargaining chips and all of the current reform
proposals would impose much farther-reaching and dramatic change than state employees will
likely tolerate. This leaves the Unions with one choice: bargain to reduce benefits even if the
negotiated agreement is only slightly better than what would otherwise be enacted without
negotiations. At least this way the Unions maintain what is most important–collective
bargaining.
29
David Lowe, Chairman for Californians for Retirement Security, stated in a recent
article, that while the Unions would support several measures to curb pension costs, they
vehemently oppose any measures that would erode what he called “the present system's
central pillars.” These pillars include state employee pensions and the collective bargaining
process as the primary vehicle for determining state employee benefits. Specifically, the
Unions support measures that curb pension spiking and excessive retirement payouts. They
also encourage CalPERS to create pension reserve account for use during bad economic times
and support reasonable changes to post-retirement employment policies. Further, the Unions
support a voluntary worker and employer contributions into 401(k) plan that supplements the
defined benefit pension plan.
However, the Unions clearly prioritize the maintenance of a defined benefit plan,
presumably at the current levels, and retaining collective bargaining as the central process for
determining retirement and other benefits for state employees. Lowe asserted that “Collective
bargaining must remain central to the process. Pensions are part and parcel of a larger wage
and compensation structure. Public employers and the unions that represent their workers must
maintain the authority to negotiate over pensions.” (Lowe 2011). This sentiment is
supported by the Dills Act, which clearly provides Unions with the authority to negotiate these
issues on behalf of employees. The unions would oppose any reform that resulted from a
process other than collective bargaining or that eliminated defined benefit plans for public
employees.
The previous section discussed the negotiating parties and their specific and often
conflicting interests. The next section will discuss how these conflicting interests can be
30
represented in “Game Theory” and how various strategies can be used to determine which
measures should be supported by the Unions
31
CHAPTER 4
LABOR NEGOTIATIONS AND “GAME THEORY”
Axelrod’s 150-game computer analysis that indicates that a “Tit-for-Tat” negotiation
strategy provides the most favorable results when compared to other strategies. The “Tit-forTat” strategy suggests that a player be cooperative in the initial negotiation round and, in
subsequent rounds; mimic the “opponent’s” approach. (Axelrod)
While in computer simulations “Tit-for-Tat” outperforms other “game theory”
strategies, Dixit and Nalebuff point out that when applied to human behavior the possibility of
misperceptions between the negotiating parties undermines the potential for a mutually
beneficial outcome because it can lead to longstanding feuds where the negotiating parties
alternately attack one and other until there is a second misperception which encourages both
parties to again act in a conciliatory manner. It should be noted that the likelihood of one
party misperceiving the other party’s cooperative action as an aggressive action was more
likely than one party believing that an act that was intended to be aggressive was conciliatory.
They argue that a “Tit-for-Tat” where each party exercises patience toward the other is
preferable because it can prevent the misperceptions that lead to negotiation impasses. (Dixit)
However, Haber notes that while this strategy may prevent the havoc-wreaking
misperceptions, it can leave the party exercising patience vulnerable to greater aggressiveness
on the part of the other party in an attempt to test this patience.
Another potential strategy is represented as the game of “Chicken” where each party is
interested in pursuing its own self-interest; a party’s optimal strategy depends on what it
believes the other party’s strategy will be. That is, if management believes that labor will be
conciliatory, then an aggressive approach is more beneficial. Conversely, if it believes that
32
labor will be aggressive, then a conciliatory approach would be better. Labor, of course, must
act in the same manner. However, if faced with a situation where one or both parties believes
it has a superior bargaining position relative to the other or that it have more to gain by being
aggressive than it has to lose, then one or both may opt for an aggressive strategy that leads to
negotiation impasses. In short, Haber’s work elucidates that while a conciliatory approach
will yield a mutually-beneficial payoff in a symmetrical negotiation, real-world negotiation
are often wrought with several limiting factors including the incentive for each party to
attempt to maximize gains through an aggressive approach, the likelihood of misperceiving
the other party’s actions or bargaining strength, and asymmetrical bargaining situations where
one party clearly has a favorable position relative to the other party.
Like most labor negotiations, both the State and the Unions have dual incentives. While
each has the incentive to cooperate with the other for their mutual benefit, each also has the
incentive to compete in an attempt to achieve the largest gain possible. Further complicating
these dual incentives are the long history of frequent contract negotiations over a variety
issues in addition to the codependent relationship and, in many ways, overlapping interests,
between the Unions and the State. While the unions and the State each seek maximum gains
for their respective positions–highest wages, superior benefits, and best working conditions in
the case of the Unions and maximum budget savings and favorable public sentiment for the
State—these interests are somewhat mitigated by the understanding that short-term gains can
have severe consequences long-term.
First, because of the continual negotiations between the two entities, aggressive actions,
including those that are perceived to be aggressive, can result in negotiation impasses
detrimental to both parties in addition to the potential longstanding mistrust that may develop.
33
Second, if the proverbial pendulum swings too far to one side, it will inevitably have to swing
quite swiftly in the other direction to mitigate the negative impacts. That is, if the Unions
secure wages and benefits that are too costly to be sustainable, at some point in the future the
state will have to make deep cuts to benefits or layoff employees. This is exemplified by SB
400 victory of 1999 that helped create the present pension reform crisis. Similarly, if the state
reduces wages and benefits to a level where it is no longer a competitive in the job market,
then it will suffer losses in productivity or have to make substantial increases in wages and/or
benefits to attract qualified employees. This is supported by succession planning issue the
state has had over the years as high ranking employees leave for the private sector to earn
higher wages. Despite, this complicated relationship, each contends that it is working in the
interests of the greater long-term good.
While, the long-standing history of negotiations and highly publicized nature of the
current pension debate make misperception between the Union and the State unlikely, another
more important of Haber’s observation will play a critical role in the outcome of these
negotiations—the asymmetrical nature of the pension negotiations. The fact is, current
benefits are unsustainable long-tem, the economy is faltering, and public support for state
employees is wavering. While statute clearly outlines that collective bargaining is the only
method through which public employee pensions should be determined, as discussed above,
several other entities have the power to directly or indirectly impact negotiations. Furthermore
numerous proposals have been introduced that would prove far more devastating to state
workers in the short-term that pension benefit reductions, making longer-term considerations
like pension benefits less important to workers.
For these reasons, the Unions simply cannot afford to play a game of chicken with the
34
state or allow for any misperception of their actions because they only stand to lose those
items most critical to their continued relevance in negotiations: collective bargaining, wages,
and jobs. Their only option is to adopt the conciliatory approach suggested by Dixit and
Nalebuff. The Unions must make large enough concessions to maintain the institution and
efficacy of collective bargaining, and protect as much as possible, state worker jobs and takehome wages to avoid losing employee support. The next chapter evaluated individual
measures based on common evaluation criteria.
35
CHAPTER 5
ANALYSIS OF REFORM ALTERNATIVES
Evaluation Criteria
When determining which measures should be implemented, it is important to consider
several different issues. Common evaluation criteria include efficiency, equity, legality,
political acceptability, and administrative feasibility; however, administrative feasibility will
not be considered, as it is not as important a concern as the others (Bardach 2009). Each
alternative will be evaluated based on these criteria to determine if it presents the most viable
options for the Unions to resolve the current pension reform debate.
Efficiency
As stated above, the debate around pension reform began due to high unfunded
liabilities, high and unpredictable costs to the state’s costs for pension benefits, and
increasingly negative public sentiment; therefore, the most important evaluation criteria will
be how effectively each alternative resolves these issues. These costs include current costs for
employer contributions and potential future costs due to unfunded liabilities. Since the
unstable and unpredictable nature of employer contributions under the current system presents
an additional challenge for the state to project costs, each alternative will also be evaluated for
its ability to stabilize employer contribution rates. Additionally, this analysis will also
consider the short- and long-term impacts of each alternative; short-term reductions provide
temporary relief, but ultimately do not resolve the issue. Therefore, alternatives that provide
long-term reductions in costs or unfunded liabilities will be favored over those that provide
short-term or no reductions. For the purposes of this paper, measures that efficiently reduce
36
costs and unfunded liabilities will be considered an effective way of avoiding mandates
through negotiating reform.
Equity
Equity in government policy is an important concern and of even greater concern from
the Unions perspective. It focuses on ensuring that the impacts of any policy changes do not
result in inequalities or negative externalities that significantly impact one population more
than any other. Because of the nature of pension reform, and the number of stakeholder
groups affected, equity in this case is a multifaceted issue. Equity measures the balance
between the benefit to the employee and the cost to the taxpayers and the impact on other
resources. It also considers the alignment of benefits and/or total compensation of state
workers and private sector workers, as well as amongst state employees. Specifically, this
criterion will focus on the economic cost to the state and taxpayers, how alternatives affect
current employees and future employees, and how risk is managed amongst all of the
stakeholders. A higher sense of shared impacts amongst all stakeholders will indicate a high
degree of equity with a lower degree of equity indicated by unfair distributions of inequalities
amongst stakeholders, or an unfair benefit between groups. In their capacity, Unions should
be primarily focused on ensuring that state employees are not unfairly impacted relative to
other stakeholder groups and make every attempt to maintain a level of shared impact amongst
current and future state employees.
Legality
State employee pension benefits are regulated by federal and state laws that dictate
which types of alterations can be made to pensions and how they must be implemented. As
discussed above, the courts have clearly prohibited several types of alterations to pension
37
benefits for current employees, while allowing others. Many proposals, if implemented on
current employees, would violate state or federal laws, and therefore, could only be applied to
future employees. Any proposals that violate law will likely be challenged in court and
eliminated, which voids any potential benefit, but would also yield potential costs for
litigation and wasted staff time. Alternatives that violate state or federal laws or that have a
high likelihood of being challenged in court will be eliminated. When they are legally
applicable to certain employees, the impact of having disparate policies and reduced benefit
due to their limited application will be reviewed.
Political Acceptability
Political feasibility considers what changes are possible given the current political
environment. It is especially important because any amendments to current or future
retirement benefits will require political support in an environment that is heavily in favor of a
reduction in retirement benefits. Any changes to the pension system must be implemented
through cooperation of the Legislature and Executive branch, with support of state employee
unions, taxpayer advocacy groups, and other stakeholders. Current legislative proposals and
analysis of past proposal provide insight into the political feasibility of each option. Options
that will likely yield widespread support (or at least not incite fervent opposition) will be
favored over those that will likely have ardent opposition from one or more stakeholder
groups.
38
Analysis of Negotiating Points
Previous chapters have discussed reform proposals, the Unions interest, the negotiation
dynamic, and evaluation criteria; this section will use the evaluation criteria to determine if
individual measures present a viable reform option to inform the later pension reform
recommendation.
While the purpose of reform is to reduce current and future costs to the state for state
employees’ retirement benefits, the options are not evaluated based on potential savings. This
paper assumes, as has been stated by CalPERS and the Legislative Analyst Office, that any
estimated savings are at best speculative and based on assumptions, many of which will prove
to be untrue over time. This is also supported by the wildly different savings and unfunded
liability estimations presented by the reputable organizations that have been cited in this
paper. Instead of attempting to quantify savings, this paper will assume a long-term savings
for each measure, while recognizing a short- to medium-term cost, and evaluate each based on
its ability to achieve other stated goals considering cost assumption. Before considering each
option individually, it is important to note the Unions best alternative to negotiations.
Status Quo
The premise of this paper is that the Unions must support and ultimately attempt to
negotiate pension reform to avoid having state employee pension benefits determined outside
of the collective bargaining process. It is, however, important to discuss the option to
maintain the status quo. Under this option the Unions would do nothing, the result of which
would likely be that one or more of the reform measures discussed in previous sections would
be implemented through an alternative policymaking processes.
39
While providing the best alternative to negotiations, this option does not present a good
option based on the Unions stated goal and the evaluation criteria. It encourages benefit
alteration outside the collective bargaining process and, based on local elections, will likely
significantly amend or eliminate defined benefit plans. Furthermore, this option alone does not
reduce the state’s cost for state employee retirement benefits or reduce the unfunded liabilities.
Most importantly, it is the very adherence to the status quo that has caused the most severe
issues currently facing CalPERS, and consequently, plaguing the Unions and state employees.
While these may be improved by external forces such as a market upturn, the lack of internal
control makes this option ineffective and inefficient at reducing current and potential costs. In
addition, it will do nothing to improve public sentiment, and could actually make it worse.
The current system is, however, entirely legal and administratively feasible. Since it
was created with adherence to law and would require no changes, it presents no potential for
being challenged in court or violating current law. Similarly, since this option would require
no changes to the way the retirement system is administered, the infrastructure already exists
so the status quo alternative presents no additional costs or implementation challenges.
When analyzing how equitable this option is, it is important to consider impacts on
various stakeholders including current and future state employees as well as the State and
taxpayers. While employees hired after January 1, 2011 will have an inferior retirement
formula than those hired prior to that date, creating an inequitable distribution of responsibility
for newer employees, this proposal would not enhance that inequity, and is therefore,
considered equitable when considering the impacts on current and future state employees.
However, when looking at the impact on state employees versus the impacts on the state and
taxpayers, this alternative results in inequitable costs to the state and taxpayers which could
40
ultimately divert funds from critical programs and services or increase tax rates to pay for the
cost of the employer contributions or to cover the costs resulting from unfunded liabilities.
Furthermore, while employees enjoy a consistent retirement contribution, the State’s employer
contribution rate changes from year to year. Over the past 10 years alone, it has gone from a
low of zero percent to a high of 30% (CalPERS, 2009). More importantly, the government
and ultimately taxpayers hold 100% of the liability for pension benefits while state employees
hold none. For these reasons, as stated above, the status quo would likely yield some form of
change to state employee benefits in the near future and therefore, does not actually provide
any benefit.
Maintaining the status quo has historically been politically acceptable. Legislators and
other government leaders have already agreed to the current system and have generally killed
any legislative proposals intending to dramatically alter the status quo. However, in recent
years, the high and unpredictable cost of retirement benefits, insufficiently funded pension
funds, and waning public support suggest that the status quo is no longer acceptable, as
evidenced by the Legislative and the Governor’s pension reform proposals and recent local
elections. Elected officials cannot allow for the perception that they are not being responsive
to the voters they represent.
The primary benefits of the status quo alternative is that it is administratively feasible,
requires no negotiation concessions, and presents by far the best alternative for recruitment
and retention since the current benefits provide a stronger incentive for qualified employees to
join or stay with the state than any proposed reform plans. However, because this option does
not efficiently or effectively address the underlying problems pension reform aims to resolve,
it will likely result in some form of cost mitigation such as lay-offs, furloughs, or mandated
41
reforms which would present a worse situation for Unions and the collective bargaining
process.
Furthermore, some of the reform measures suggested by the proposals should be
implemented because they prevent the fraudulent or questionable practices that, to some
extent, have led to the current economic situation and have created a public relations issue for
the Unions and state workers.
Voter Approval of Benefit Increases
While requiring voters to approve all benefit increases would prevent unreasonable
benefit increases and provide voters with input into state employee benefits, it could present
an unnecessary cost and not yield a benefit that cannot be achieved through existing means.
More importantly, this paper is based on the assumption that benefit policy should be
determined through the process outlined in the Dills Act; allowing voters to vote on retirement
benefit changes is also contrary to the Union’s mission.
Increase Contribution Rates
All three proposals propose to increase employee contribution rates to equal the
employer contribution rate indicating that this is widely accepted and presents an effective and
efficient cost-cutting measure. Increases in employee contributions would provide greater
assets in the pension fund, reduce and stabilize employer contributions, equitably distribute
the cost of benefits among all stakeholders (depending upon how it is implemented), and
provide one of few options that could potentially be legally applied to current and future state
employees. Since it does not require changes to the existing infrastructure, it would achieve
these ends with minimal administrative impacts. However, in light of recent employee
contribution increases, this may be perceived by current employees as unfair and would have a
42
greater impact on lower paid state employees who have disposable income near California’s
minimum cost of living.
Increasing employee contribution rates would result in more assets in the pension
system, which can then be invested to earn additional returns and yield even greater assets in
the future. The California Legislative Analyst Office (2010) estimates that a three percent
increase in the employee contribution rate for roughly 95,000 state employees, would result in
General Fund savings of $100 million a year. (LAO Analysis, 2010). It would also
substantially reduce the state’s costs for employer contributions and provide stability that
encourages longer-term planning for retirement costs. While effectively reducing the State’s
costs and providing the greatest short-term effect on reducing unfunded liabilities, increasing
employee contributions does not reduce actual future liabilities (Rauh & Novy-Marx, 2010)
and, if not implemented using actuarial policies that reduce wild fluctuations in employee
contributions, it could make it difficult for employees, especially those with lower incomes, to
plan effectively for their immediate financial future.
If implemented for both current and future employees, it would, however, present the
most equitable distribution of impacts on all stakeholders because it equally impacts current
and future employees and divides the cost of benefits amongst employees and the state and
taxpayers. As stated above, it is one of few measures that could legally be implemented for all
employees, although there is disagreement about the legality of the Legislature increasing
current employees’ contribution rates. While judicial precedent asserts that DB retirement
plans constitute deferred compensation and cannot be reduced or eliminated, it has also held
that contribution rates for employees can increase or decrease through state statute, or
memorandums of understanding (MOUs) Betts v. Board of Administration, 1978). The
43
Legislative Analyst’s Office, in its analysis of the Governor’s 2011 Pension Reform Proposal,
however, states that “it will be very difficult— perhaps impossible—for the Legislature, local
governments, or voters to mandate such changes for many current public workers and
retirees.” It also discusses concerns about how any savings realized through increases in
employee contribution increases “likely will be offset to some extent by higher salaries or
other benefits for affected workers.” The LAO cites several court interpretations to support its
assertion. In the Pasadena Police Officers Association case, the appellate court determined
that an employee “has a vested right not merely to preservation of benefits already earned...but
also, by continuing to work until retirement eligibility, to earn the benefits, or their substantial
equivalent, promised during his prior service.” The LAO does concede that the California
Supreme Court has allowed increases in employee contribution rates pursuant to city charter
and ordinance provisions that allowed it to do so and that the Ninth Circuit federal appeals
court further distinguished between legislatively enacted reductions in employers’ payment of
a share of employees’ required pension contributions, which was deemed allowable, and
legislatively imposed increases in the total amount of required employee pension
contributions, which was deemed a violation of contract law. However, the LAO maintains
that outside collective bargaining the state would not fall under either of these caveats.
Based on this belief, the LAO advises that the Legislature to focus primarily on
changing to future workers’ benefits, rather than those of current state workers, though they
acknowledge that this would only result in long-term relief, and do little, if anything, in the
short-term. If implemented in this manner, this option would obviously have a
disproportionately negative affect on future workers who will be funding current workers
superior benefits.
44
Politically, policymakers have been reluctant to upset employees or their union, which
is why employee contribution rates have remained low throughout the years (Rauh & NovyMarx, 2010). However, the current situation has created an environment where employee
contribution rates were increased suggesting that this option is politically more palpable
amongst policymakers and DPA, though this recent increase may make the Unions reluctant to
agree to further increases which, based on the LAO’s analysis would make it difficult, or
impossible, to implement for current state employees which would eliminate any short-term
saving.
Change Retirement Plan Type
Historically, there have been two types of retirement plans available—defined benefit
(DB) and defined contribution (DC). Defined benefit public pension plans continue to be the
main retirement vehicle for most public employees; however, most private businesses may
have never had a DB plan option for their employees or may have switched from a DB plan to
a DC plan to reduce costs (Snell, 2010). The key difference between these plans is how
investment risk is handled. In most defined benefit plans, the employer bears most of the
investment risk. By contrast, in defined contribution plans, the employer is only obligated to
make specified retirement contributions during the years that employees work; therefore,
employees and retirees generally bear all investment risk. In recent years, hybrid retirement
plans that incorporate aspects of both DB and DC plans have emerged in both the private and
the public sector. Many pension reformers suggest that the public sector phase out DB plans
and provide a DC retirement plan or a hybrid retirement plan. The next section will discuss
each of these types of retirement plans, their benefits and drawbacks, and how they are or
would be implemented in the state.
45
Defined Benefit Plans
As discussed in the introduction, a defined benefit plan provides a lifetime annuity
after retirement that is based on a predetermined retirement formula that takes into account the
age at retirement, number of years of employment, highest salary for a certain amount of time
(1 year, 3 years, etc.), classification (safety, miscellaneous, or patrol), and a predetermined
retirement multiplier (expressed at a percentage). In theory, the combination of employer
contributions, employee contributions, and investment returns will provide sufficient assets to
pay future retirement benefits. However, in reality, this is not always the case, leaving the
State liable for all future retirement obligations and providing employees with a liability-free
benefit. This inequitable distribution of liability also subjects the State to higher and more
unpredictable current retirement costs than experienced by employees.
DB plans clearly benefit employees as they provide predictable contribution rate and
guaranteed retirement income, with little upfront cost and no market risk. The benefits to the
state include the increased recruitment and retention of qualified employees since DB plans
are rare in the private sector, and, to a lesser extent, the reduction in retirees who access social
welfare programs due to insufficient retirement savings. Despite these benefits, the high and
unpredictable costs have led to an unsustainable system where costs outweigh the benefits of
this type of plan. Many private and, more recently, public employers have switched to a
defined contribution plan that reduces or eliminates the costs and risks of DB plans.
Defined Contribution Plans
A defined contribution plan (DC) provides a lump sum payment paid after retirement.
401(k) plans, 403(b) plans, employee stock ownership plans, and profit-sharing plans are all
examples of DC plans. In these types of plans, the employee, the employer, or both contribute
46
a fixed amount to the employee's individual account that is invested at the employee’s
discretion (US Department of Labor). DC plans are usually administered by a third-party and
participation is generally optional. Employees determine their contribution rate and how their
funds are invested. Employers determine how much, if any, they will contribute to DC the
plan, and are only liable for the contributions outlined in the employment contract. As a
result, the employee bears all of the risk and employers have no future obligations. The lump
sum benefit provided at retirement includes the total contributions plus or less investment
earnings or losses, respectively. The employee is responsible for allocating the appropriate
amount of income to retirement, investing the retirement account, and ensuring that after
retirement the lump sum is managed appropriately to provide lifelong income security.
Opposite DB plans, DC plans clearly favor the employer because they require lower,
if any, employer contributions and present no market risk to the employers for future
retirement liabilities. A State-run DC plan would likely be similar to the ARP, which unlike
traditional DC plans, requires an employee contribution and is invested by DPA rather than
the employee. Also, presumably the state would contribute more than the average private
sector employer. Despite these deviations from traditional plans, a DC plan would present the
largest reduction in retirement costs for the state. The Legislative Analyst Office estimated
that, by shifting from a DB to DC plan, California would save between a few million dollars
to over one billion dollars annually (LAO, 2005). CalPERS’ analyses have also suggested that
despite the high upfront cost, a DC plan would yield substantial saving in the future. It
estimated that the cost to implement a DC plan would be $820 million in the first year, mostly
associated with setting up the numerous 401(k) accounts, but would result in about $16 billion
in savings over the next 20 years and would increase to $36 billion in savings over 30 years
47
(Archie et al., 2006). In addition to the future savings realized in a DC plan, a DC plan would
provide the State with more predictable current and future costs for retirement.
Unlike a DB program, which requires the employer contribution to fluctuate from year
to year, based upon funding levels and market conditions, DC plans either do not have an
employer contribution, or have fixed contribution rate that does not fluctuate (Summers,
2010). Similarly, since DC plans are not considered deferred compensation plans, the
employer does not hold any obligations to fund any future liabilities (Munnell et al., 2008).
Combined, these allow the state to make more accurate long-term projections for retirement
costs that increase financial stability, in a way that is impossible under the current system.
While having clear benefits for the State, DC plans present several unintended financial
consequences in addition to those affecting how this paper evaluates this alternative.
New members enter a DB system without unfunded obligations since they are so far
away from vesting requirements and minimum retirement age making their contributions
worth more than the projected cost their retirement benefits. The one dollar invested in the
plan by the employee is not worth as much as one dollar invested by a person about to retire.
As a result, unfunded liabilities are not reduced for existing members when new members are
enrolled into a DC plan (Olleman, 2009).
Olleman points out that by removing future employees from the DB plan the system
also removes unrealized future assets in the pension system. Current employees in DB plans
subsidize previous employees who are now retired and future employees will subsidize current
employees once they retire. With no future employees contributing to the DB fund, future
unfunded liabilities rise even higher and require higher current contributions to offset future
retirement liabilities for current employees (Olleman, 2009).
48
In addition to the unintended consequences observed by Olleman, switching to a DC
plan would have other drawbacks including higher administrative costs and difficulties,
recruitment and retention benefits, and reduced retirement security for new hires.
Administrative costs for DB plans are typically around 0.3% of assets, while DC plans usually
have an administrative cost of 1.1% (Munnell et al., 2008). Since the State currently offers a
DB plan, the infrastructure already exists and requires no upfront costs to implement; as
indicated above, implementation of a DC plan would require substantial up-front investment
(however large the potential long-term savings may be). Additionally, because DC plans are
common, the State would lose an important recruitment and retention tool and may have to
increase expenditures for other forms of compensation to remain competitive in the job
market. Although of lesser importance for the purpose of this paper, this option also runs the
risk of increased expenditures on costly social welfare programs due to higher enrollment
resulting from increased number of retirees without sufficient retirement income. These
drawbacks could be mitigated to some extent by employee and the employer contribution
requirements that encourage adequate retirement savings and reduce recruitment impacts.
Though obviously presenting cost savings and surmountable administrative
challenges, proposals to implement DC plans have been politically unpopular making it
unlikely that CA State employees will be subject to one in the near future. The hybrid option
has been introduced in attempt to provide a “middle ground” option that equitably distributes
costs and benefits to both employees and the employer.
Hybrid Plans
Hybrid retirement plans were introduced to capitalize on the benefits of both retirement plan
types and mitigate the drawbacks of each. A hybrid plan provides retirement benefits that
49
combine various aspects of DB and DC either into a single plan or uses two or more separate
plans to provide both DB and DC benefits. The extent to which each resembles the respective
plan types depends upon how the hybrid plan is developed and implemented, including the
retirement formula used for the DB portion, retirement contribution structure, and whether the
DB and DC portions are integrated into one or allocated to more funds. Generally, they
appear like a DB plans to the employee, but like a DC plan for the employer.
Like a DB plan, in a hybrid plan the employer, who is also the plan administrator,
invests plan assets as a whole (through one or more funds) and bears the risk of investment
gains and losses. However, like DC plans, they are funded through employee contributions,
and if outlined in the employment contract, an employer contribution, in addition to
investment returns. The employee contributions follow that of a DB plan, where the employer
deposits a portion of the employee’s pay into an account (United States Department of Labor,
2010). This differs from a DC plan where the employee is responsible for funding the account
and the employer has the option to match all or a portion of the employee contribution
(Turner, 2003 & Clark et al., 2001). Like DB plans, hybrid plans also provide an annuity after
retirement (Turner, 2003) rather than a lump sum at retirement.
Because a hybrid plan it is a combination of the previously discussed retirement plan
types, it presents both the advantages and disadvantages of each type. The extent of the
benefits and drawbacks experienced depends upon how large the DB and DC components are
and how the retirement funds are managed. The Governor’s plan provides the most detailed
proposal of how, if implemented, a hybrid plan for state employees might look.
For Non–Public Safety Employees, the hybrid plans would be based on employer and
employee contribution schedule that would aim to produce a retirement income equal to 75
50
percent of an employee’s pre-retirement salary after 35 years of service. The DB portion, DC
portion, and Social Security income would each represent approximately one-third of the total
retirement income. For employees not in Social Security, the DB portion would comprise
two–thirds of the retirement income with DC portion covering the remainder. Public Safety
Employees’ contributions would similarly aim to produce a retirement income equal to 75
percent of an employee’s pre-retirement salary, but after only 30 years of service, but would
follow the allocations to DB, DC, and Social Security, if applicable, as listed above.
The primary benefits of hybrid plans are that they provide a stable source of income
for retirees, are portable, and provide predictable employee and, if applicable, employer
contributions. As an alternative for pension reform, switching to a hybrid plan presents
several distinct advantages for the state and employees, and is therefore, widely supported.
The lower and more predictable employer contributions allow for better planning and in the
long-term will reduce unfunded liabilities. It will also reduce the likelihood of retirees
enrolling in social welfare programs due to insufficient retirement funding or inadequate
retirement planning. In Seekats’ CAM analysis, hybrid plans continually received the highest
total score based the previously mentioned evaluation criteria and when examining the
potential tradeoffs, the benefits overshadowed any costs and risks. (Seekats, 2010).
Furthermore, the implementation of a hybrid plan for state employees is widely supported by
citizens and elected officials, making it politically feasible and because it maintains a DB
component, it would likely be more acceptable to Unions, than other options.
The primary drawback is the high upfront cost and difficulty to implement and
administer of two plan types. Also, depending on how it is implemented, while it will reduce
employer contribution costs for the state, it could also reduce contributions into the DB fund,
51
which could increase unfunded liabilities like switching to a DC plan as discussed above.
Furthermore, under current law it could only be implemented for new employees, which
would create unequal benefits for current employees and new hires, and could be opposed by
the Unions. Despite numerous clear advantages, this paper suggests that the Union only adopt
this provision if it is the only alternative to converting to an entirely DC system. Although a
hybrid plan maintains a DB component, it erodes this component and puts state employees
one step closer to an entire DC retirement plan. Furthermore, if it fails to yield expected
savings, as it likely will not for many years, or is perceived to fail, the state and proponents of
a DC system for state employees will have even more support for implementing a DC plan.
Impose Pension Benefit Cap
Salary caps could come in the form of a maximum percentage of income used in final
compensation calculation, a fixed amount of income that can be used to determine post
retirement benefits, or as a maximum retirement benefit allowable. Regardless of the type of
cap imposed, employees would be allowed to contribute to a 401(k) plan after they reach the
cap to supplement retirement income. A 2010 U.S. Census Bureau paper found that an
individual at the median income (as of 2004) needed a retirement income between 66 percent
and 75 percent of his or her pre–retirement income to maintain a similar quality of life after
retirement because they no longer pay deductions such as social security and health benefits
and have reduced transportation, clothing, and other expenses associated with working.
While the average annual service retirement income is just under $28,000 per year,
which in most California county’s would be low to moderate income (CalPERS, Housing and
Community Development 2011), a 2005 LAO report suggested that some employees,
especially those in safety and patrol classifications, can earn retirement incomes far exceeding
52
this required “replacement income,” particularly when Social Security and other sources of
retirement income are considered (LAO, 2005). Despite the low average retirement annuity,
data suggests that the largest portion of the state’s cost for retirement benefits--approximately
60 percent--are for retirees with 25 or more years of service. This group’s retirement payout is
between $53,000 and $66,000. While pension reformers cite the higher than necessary
retirement payouts as the justification for deep reforms, the consistent coverage of public
employees earning six-figure retirement incomes (approximately two percent of CalPERS
retirees) has further fueled the pension debate and negatively impacted public sentiment.
Benefit caps, either on compensation allowed to be used in final compensation or on
maximum retirement benefit would create a more reliable prediction of future unfunded
liabilities, and in the eyes of taxpayers, would create more legitimate and fair benefits
allocations. It would also reduce maximum retirement payouts, and consequently reduce the
states costs for state employee retirement. While a hard cap on benefits would provide the
greatest predictability and cost-containment, it could backfire and encourage workers to retire
earlier than they otherwise would, once they reach the maximum. This would leave the state
without their experience and expertise and could increase liabilities by increasing the number
of years employees receive benefits. (Little Hoover) To reduce this externality, the State could
implement caps on salary used in final compensation calculations or on the percentage of
salary used to determine final compensation and allow employees to invest in a 401(k) plan to
supplement income.
This alternative would efficiently reduce the state’s costs for retirement benefits and
increase stability in employer contribution; however, it could reduce contributions to the fund
once employees reach the maximum. The extent of the reduction would depend upon how the
53
caps are implemented. This would also effectively improve the public’s perception of state
employees’ pensions because it would reduce the number of six figure retirement payouts and
more closely align state worker retirement plans with those in the public sector and reduce the
state’s cost for retirement benefits.
Since benefit or salary caps would reduce cost and align public and private sector
retirement benefits, this alternative would more equitably distribute the costs among state
employees and the state (as well as taxpayers). Presumably, it would also impact current and
future state employees equally; however, this would depend upon how the Supreme Court
viewed the cap. Based on precedent, it seems that salary and/or benefit caps more closely
resemble increases to employee contributions, which have been rendered Constitutional as
long as they are changed through collective bargaining or statute; however, strict Legislative
mandates, as indicated above, may not be legally implemented for current employees.
Caps on benefits allowable appear to be widely supported by the public and are
included in the Public Employee’s Reform Act and the Little Hoover Commission’s
recommendations. The Governor’s original pension reform proposal also included benefit
caps; however, his most recently released proposal excludes benefits caps. Because of the
widespread support, this option would be politically acceptable. Administratively, it would
present upfront costs and challenges to implement, including the cost to change IT
infrastructure and determine the appropriate caps.
Increase Retirement Age
As discussed above, currently most state employees can retire as early as age 50, with
maximum benefits achieved by retiring at age 63. Recent MOU negotiations have increased
the minimum age at which new employees can retire to age 63. The average retirement age
54
for state employees at age 60 (CalPERS). All three proposals include an increase in the
retirement age, the highest of which would increase the full retirement age to 67 to align the
full retirement age with the age at which a person qualifies for Medicare and Social Security.
By increasing the minimum retirement age, capable employees would be encouraged to work
longer, thus helping the state maintain knowledgeable and experienced employees for more
years, reducing the number of years an employee draws a retirement benefit, and increasing
the number of years an employee contributes to his or her retirement.
By keeping employees on the job longer, unfunded liabilities can be reduced in two
ways. First, the employee is required to work longer on the job, and consequently contributes
more to the pension system in the form of employee contributions. The second relates to life
expectancy and the reduced number of years that the retiree will be able to draw from the
pension system after they retire. With the retiree able to draw on less years of retirement, the
amount of each employee’s liability declines.
Rauh & Novy-Marx, in their 2010 study, analyzed the effects increasing the retirement
age have on unfunded liabilities. In their study, they were able to quantify that a one-year
increase in the retirement age resulted in a two to four percent reduction in liabilities because,
with the retiree able to draw on less years of retirement, the amount of each employee’s
liability declines (Rauh & Novy-Marx, 2010). However, this is a long-term solution and will
not reduce unfunded liabilities in the short-term because case law does not allow for increases
in retirement age for current employees; making is only possible to increase the retirement age
for new employees (Betts v. Board of Administration, 1978).
Because of this unequal treatment under the law, this would create an unequal benefit
for current and future employees because one group of employees would be able to retire five
55
years earlier than the newly hired group of employees. It would, however, create a more
equitable distribution of costs among state employees and taxpayers though it is not entirely
equitable since it will still mandate erratic employer contributions, and 100% of the liability
still resides with the state and future state employees would do little to reduce the current
unfunded liabilities. This alternative could also result in increased retirement payouts due to
salary increases or promotions that could occur over the additional years of service. State
employee’s, at a minimum, earn a five percent merit increase each year and generally have the
potential to promote into a new rank each year as promotional exams are available. While
increases in retirement age encourage or require employees to work longer, other policies that
could yield a similar, albeit reduced, effect include increasing the minimum number of years
required to earn retirement benefits, increasing the ARP period discussed above, or increasing
the number of years used to determine final compensation.
Increasing the number of years of service required to qualify for or get the maximum
retirement benefit encourages employees to work longer which yields benefits similar to those
experienced when the retirement age is increased. The key difference is rather than setting a
minimum age, which requires employees entering state service at a young age to work longer
than those who enter at an older age to realize full retirement, setting a minimum amount of
years of service would require all new employees to work the same number of years to earn
the same benefit. This would naturally render some employees who enter state service too late
in their lives to fully vest ineligible for benefits, or at least the maximum retirement benefit. It
could also allow younger employees to retire earlier, assuming the minimum retirement age
does not prevent this, once they earn enough years of service credit. The state attempted a
form of this concept when it introduced the Alternative Retirement Program.
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In an attempt to reduce the states cost for state employee retirement benefits, in 2004,
the state introduced the Alternate Retirement Program (ARP). ARP is a DPA-administered
retirement savings plan that all new, first-time State Miscellaneous and Industrial employees
are automatically enrolled into for the first two years of employment in lieu of the CalPERSadministered pension plan. New employees have approximately five percent of their salary
automatically deducted as a pretax contribution to fund the account. The State; however, does
not make any contributions to this account and employees do not earn service credit during
this time. After two years of state employment, employees are automatically enrolled in
CalPERS. Once enrolled, the state begins to contribute to their pension and employees begin
earning service credit. After four years of employment, employees can “buy-back” the two
years of CalPERS service credit they would have earned had they become a member of
CalPERS upon hire. Employees who choose not use these funds to buy service credit have
their retirement savings transferred to a DPA-administered 401(k) retirement plan.
ARP reduced the State’s contribution to employee retirement and eliminated it for
short-term employees. It also encouraged many employees to work longer to maximize their
retirement benefit. While the implementation of ARP yielded retirement short-term cost
savings for the state, they proved insufficient to maintain the solvency of the retirement fund
after the economic downturn. Increasing the number of years employees are enrolled in ARP
reduces the state’s current retirement cost since the employer does not contribute during this
period. However, it also increases the number of years before new employees begin
contributing to the fund, which as discussed above increases unfunded liabilities. Also, since
under current law employees can purchase ARP time as service credit, many employees may
opt to purchase time rather than working additional years which would undermine the savings
57
resulting from additional years of work or reduced years receiving a retirement benefit;
however, if air time is eliminated as is likely to happen, this would not be an issue.
Similar to increasing the number of years required to earn a maximum benefit and
increasing the number of years an employee remains in ARP, increasing the number of years
used to determine final compensation could reduce pension payouts or encourage employees
to work longer to have the highest average salary used to determine final compensation.
Currently the final compensation used to determine retirement annuities is based on the
highest average 12 to 36 months salary, the Hoover Commission recommends increasing this
to five years. While this may encourage employees to remain or lower retirement annuities, it
could do so incrementally and possibly be offset by increases in retirement obligations for
employees who remain longer than they otherwise would have and earn salary increases or
promote.
All of these benefits would provide efficient and effective ways to reduce the state’s
employer contributions and reduce long-term unfunded liabilities; however, in the short-run,
they could increase unfunded liabilities. Long-term impacts are more important than shortterm benefits; however, the only option in this section that could result in a dramatic reduction
in short-term costs in the increase is the retirement age. Like many of the previously
discussed options, these would be considered a change to the employment contract that could
not be legally mandated for current employees; therefore, while these proposals would help
distribute retirement costs amongst state employees and taxpayers, it would create inequities
amongst state employees. These alternatives would also be administratively feasible because
the infrastructure already exists and would require little change to implement. Politically,
58
these are acceptable and have widespread support from policymakers and the public; however,
Unions will likely be opposed to these in combination with other reforms.
This section evaluated each of the individual components in the three previously
mentioned reform proposals. The evaluation criteria included efficiency, equity, legality,
political acceptability, and administration feasibility. The next section will provide
recommendations based on this analysis.
59
CHAPTER 6
RECOMMENDATIONS
The Unions have outlined two fundamental values that it must protect: collective
bargaining and defined benefit plans. Maintaining state jobs and take home wages must also
be a priority as well as those measures that can improve their public image. While fairness for
future and current employees should be maintained as possible, critical choices must be made
and must consider the fact that future employees will be opting for state employment under the
new contract; therefore, their benefits should not be given priority over the aforementioned
negotiating values. Based on the fundamental negotiating values and the analysis of the
individual measures in Chapter 8 the following changes should be supported by Unions in an
effort to protect those items most valuable to the Unions and position them for favorable
future negotiations.
First, it is in the Unions best interest to prevent employees from receiving unearned
retirement benefits that unfairly benefit some stakeholders, while negatively impacting others.
These include the elimination of retroactive benefit increases, the elimination of air time
purchases, excluding all forms of compensation other than base pay from final compensation
calculations, limiting post-retirement employment to prevent double-dipping, and rendering
employees convicted of work-related felonies ineligible to receive pension benefits. These all
have widespread support from policymakers and analysts because they help reduce unearned
pension payouts. They also demonstrate the Unions’ dedications to ending pension fraud and
help improve public sentiment, which has fueled the pension debate.
As demonstrated by the enactment of SB 400, retroactive benefits can have far greater
costs than expected leading to the long-term issues being faced today. Furthermore, they are
60
unnecessary as employees enter the employment contract with the understanding that they will
receive a specified benefit and other measures such as one-time bonuses can be used to
mitigate any unfair benefits to the state that are not equally enjoyed by employees. Similarly,
the elimination of air time purchases, excluding all forms of compensation other than base pay
from final compensation calculations, and limiting post-retirement employment to prevent
double-dipping allow for better long-term planning for retirement benefit costs and reduce an
inherent unfairness in the system because they are generally more accessible to higher income
employees. In addition, they have been used by the media to outline abuses in the system that
proved detrimental to the public’s perception of the Unions and state employees. Rendering
employees convicted of work-related felonies ineligible to receive pension benefits also
reduces the state’s cost for benefits and improves public perceptions, but can also help reduce
costly incidences of fraud by deterring would-be offender from committing such fraud. All of
these reform measures are widely accepted by politicians and analyst because they will help
reduce unnecessary costs and allow for better planning. The Unions have similarly supported
measures that help curtail fraudulent and unfair practices so these should not be seen as
concessions, but as conciliatory acts that help improve transparency and fairness n the system
and help reduce costs.
Second, the Unions should support the move to a hybrid retirement system in exchange
for a guarantee that the state will not lay employees offs or cut employee’s take-home pay
including furloughs (or their successors), increases in contribution rates after the initial hybrid
structure is set up, or any other forms of take-home reductions. This may have to include
initial increases in current employees’ retirement contributions to ensure proper funding of the
Fund; however, the state should commit to not increasing contributions any further.
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Conceding to a hybrid system will give the Unions more bargaining strength. Currently, the
Union has few bargaining chips. The economy is faltering forcing deep cuts in many essential
programs, state employers are laying off employees, and public sentiment is in favor of cuts to
state employees’ benefits. In the absence of the ability to strike, which is challenging given
labor contracts and would be imprudent even if a viable option as they would undoubtedly
turn public sentiment more against state employees, the Unions cannot prevent changes to
retirement benefits outside of the collective bargaining process. As a result, they should focus
on maintaining the defined benefit as the primary retirement savings mechanism with the
defined contribution portion providing a subsidy, especially in the case of higher wage
earners. Many studies indicate from a policy perspective, hybrid plans are the best option.
Additionally, this provides the Unions with their best chance to mitigate the negative impacts
on state employees because hybrid systems are very flexible and can accommodate a variety
of structures. Benefit caps can be incorporated into the hybrid system allowing for step
decreases as in the defined benefit portion after an employee reaches a certain post-retirement
income. Similarly, the hybrid system can be structured to encourage, not mandate, that
employees work to a higher retirement age. Most importantly, they allow the Union to appear
to the public and policymakers as if it they are attempting to solve the pension issue, while
maintaining a defined benefit retirement plan and collective bargaining as the primary method
through retirement benefits are determined. This option provides them with the greatest
impact on policy decision related to public employee’s retirement benefits and helps protect
against more critical short-term losses in jobs and income.
While other options discussed present various types of relief, they were not
recommended because, as discussed in the analysis section, they violated one of the evaluation
62
criteria or were not deemed as effective as the recommended measures based on the stated
evaluation criteria. As stated above, the status quo, while providing the best alternative to
negotiations does not effectively address underlying issues the reform must address to be
successful and will likely result in the removal of the reform process from the control of the
Unions. Furthermore, the status quo ultimately created the issue that CalPERS, the Unions,
and other stakeholders now have to address. Voter approval of benefit increases provides very
little benefit and could present an unnecessary cost. More importantly, the primary concern of
this paper is to maintain collective bargaining as the primary means of determining benefit
policy; this option directly violates that principal. Increases to contribution rates would
increase assets in the fund and be fairly applied to all employees (current and future);
however, in light of recent increases for all employees and reduction in benefits for new
employees, this option would be extremely unpopular for employees. Furthermore, most
proposals suggest that employee and employer contributions should be equal. This would
present an unfair burden on lower income employees who cannot absorb the varying and
increased costs. The imposition of a benefit cap, while being a popular option for
policymakers, present a variety of issues, chiefly that it discourages highly qualified long-term
employees from remaining with the state after they reach the cap. Also, since it can only be
applied for future employees, it unfairly burden newer employees who will be paying an equal
amount for an inferior benefit While increases in retirement age provide more assets into the
fund as employees work longer and reduce the number of years an employee draws a
retirement benefit, like benefit caps, can only be imposed on new employees and would,
therefore, inequitably impact new employees.
63
CHAPTER 7
CONCLUSION
Since the inception of the State Employees Retirement System in 1931 (now called
the California Public Employees Retirement System), a series of Constitutional amendments,
collectively bargained agreements, propositions, and legislative mandates have shaped the
System and the retirement benefits available to state employees. Now, after millions in
pension investment losses, a faltering California economy, and negative public sentiment,
state employees’ benefits are again being scrutinized.
In a social and political environment that is ostensibly in favor of large reductions in
pension benefits, the unions must make concessions to avoid being circumvented by
policymakers or voters. This paper analyzed the salient issues related to state employee
pension reform and various negotiating strategies to determine which reform measures the
Unions should support to resolve the pension reform crisis through the collective bargaining
process considering those values fundamental to state employees Unions and the employees
they represent. Based on the analysis it was determined that the Unions should support
several changes that prevent fraudulent and unfair practices including the elimination of
retroactive benefit increases, the elimination of air time purchases, the exclusion all forms of
compensation other than base pay from final compensation calculations, limitations on postretirement employment, and the rendering of employees convicted of work-related felonies
ineligible to receive pension benefits. Additionally, the Unions should support the
implementation of a hybrid system that focuses primarily on the defined benefit component in
exchange for the state’s commitment to not lay employees off and avoid making any types of
cuts to employees’ take-home pay. Through these measures the Unions can maintain
64
collective bargaining as the fundamental means through which state employees’ retirement is
determined and maintain defined benefit as the primary retirement savings mechanisms in
addition to protecting state employees’ jobs and financial security.
65
APPENDIX
Public Opinion Polls 2005 - 2010
Date
Range
Question
Results
Survey Source
1/12/2010
1/19/2010
Would you favor or oppose
changing the pension systems for
new public employees from a
defined benefit to a defined
contribution system similar to a
401(k)?
Favor (67%)
Oppose (21%)
Don’t know (12%)
PPIC:
Californians
and Their
Government,
January 2010
1/12/2010
1/19/2010
At this time, how much of a
problem for state and local
government budgets is the amount
of money that is being spent on
their public employee pension or
retirement systems?
Big Problem (41%)
Somewhat of a
Problem (35%)
Not a Problem (14%)
Don’t Know (10%)
PPIC:
Californians
and Their
Government,
January 2010
1/11/2005
1/18/2005
Would you favor or oppose
changing the pension systems for
new public employees from a
defined benefit to a defined
contribution system similar to a
401(k)?
Favor (61%)
Oppose (25%)
Don’t know (14%)
PPIC: Special
Survey on the
California State
Budget,
January 2005
Peace
Officer/
Firefighter/
CHP
At this time, how much of a
problem for state and local
government budgets is the amount
of money that is being spent on
their public employee pension or
retirement systems?
Big Problem (31%)
Somewhat of a
Problem (341)
Not a Problem (17%)
Don’t Know (11%)
PPIC: Special
Survey on the
California State
Budget,
January 2005
Source: Public Policy Institute of California (2005, 2010)
66
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