Local Agency Exits from CalPERS

After two and a half years, the Herald Fire Protection District (HFPD) has completed the process of exiting the California Public Employees’ Retirement System (CalPERS). To separate, the district was obliged to take on a costly bank loan to finance the termination liability payment CalPERS demanded. The cost and complexity of this withdrawal might serve as a cautionary tale for other small employers thinking of leaving CalPERS, but it should also lead us to question some of the inflexible policies that make exiting so difficult.

The district encompasses 96 square miles in the sparsely populated southeast corner of Sacramento County. It operates two stations staffed by volunteer firefighters who respond to fire, medical and other emergencies. Although they are volunteers, firefighters receive stipends for each shift they are on duty (ranging from $62.50 to $100 per 12 hours) as well as payments for responding to calls while off-duty and participating in drills. Additionally, the district makes social security, state unemployment insurance and worker’s compensation contributions on behalf of these volunteers.

According to district chair Lindsay Liebig, Herald first joined CalPERS in 1995 to provide a pension for its long-serving fire chief. Today, his widow receives monthly benefits of just over $2,000 a month. Right now, she is the only beneficiary of CalPERS plans that ultimately proved too complex and expensive for the small district to manage.

Liebig became chair shortly after HFPD experienced a financial scandal. In 2013, the Sacramento County Civil Grand Jury found numerous irregularities including a secret bank account in which the district deposited and disbursed revenues obtained by renting its two buildings. Liebig was appointed to the board in late 2015 and became chair in early 2017. Under her leadership, the district has cleaned up its finances earning a commendation from the Grand Jury for “the numerous steps made in increasing the ability to provide better service to their community.”

As the board worked to straighten out district finances, it made the decision to implement an all-volunteer staffing model in which even office staff would receive stipends rather than salaries. In 2016, all three employees were laid off, but two returned as volunteers.  Board members also determined that CalPERS membership no longer fit with the new staffing model.

California Public Employee Retirement Law (PERL) contains a variety of requirements that limit staffing flexibility. These provisions can have a heavy impact on small agencies, like HPFD, that have limited revenue and limited administrative capacity. For example, PERL does not distinguish between volunteers and salaried employees. Consequently, a volunteer that puts in 1000 or more hours annually becomes eligible for CalPERS retirement benefits requiring additional payments from the district. Second, retired public employees who’d like to volunteer for the district risk triggering a CalPERS rehiring provision: if they work 960 hours or more per year, they are no longer considered retired and temporarily lose their CalPERS benefits.

To avoid these limitations and free itself from unpredictable changes in pension contribution rates, the board voted to exit CalPERS in January 2016. Rather than being a final decision, the vote triggered a two-and-a-half year process that is just wrapping up. First, CalPERS required a one-year cooling off period during which the board could reconsider its decision. But the board reaffirmed its choice with a unanimous vote in January 2017. It then took CalPERS an additional 10 months to compute HPFD’s termination liability — the amount the district would have to pay to be relieved of its pension obligations once and for all.

While one might think that an agency would be able to simply pay off its unfunded actuarially accrued liability (UAAL) and leave the system, this is not the case. Although both the unfunded liability (now known as the Net Pension Liability under GASB 68) and the termination liability are calculated by estimating and discounting future benefit payments (netting out assets), the discount rates used are quite different. For UAAL (and now NPL), CalPERS is in the process of migrating from a 7.5 percent rate to 7 percent. But when it calculated hypothetical termination liabilities in its 2016 plan actuarial reports it used discount rates of 1.75 percent and 3 percent.  CalPERS explains its use of a range of lower termination liability rates as follows:

A more conservative investment policy and asset allocation strategy was adopted by the CalPERS Board for the Terminated Agency Pool. The Terminated Agency Pool has limited funding sources since no future employer contributions will be made. Therefore, expected benefit payments are secured by risk-free assets and benefit security for members is increased while funding risk is limited. However, this asset allocation has a lower expected rate of return than the PERF and consequently, a lower discount rate is assumed. The lower discount rate for the Terminated Agency Pool results in higher liabilities for terminated plans. The effective termination discount rate will depend on actual market rates of return for risk-free securities on the date of termination. As market discount rates are variable, [we show] a range for the hypothetical termination liability based on the lowest and highest interest rates observed during an approximate 2-year period centered around the valuation date.

In its November 2017 bill to HPFD, CalPERS used a termination discount rate of 2.75 percent to derive a liability of $404,535.  This compared to an aggregate UAAL of only $82,524 shown in the three CalPERS 2015 actuarial valuation reports for the district (2016 actuarial reports for HPFD are not available on CalPERS web site).  After issuing the November 2017 termination liability invoice, CalPERS determined that one eligible employee had not been included in the calculation and bumped up the final bill to $437,966.

CalPERS gave HFPD the choice of paying the entire bill immediately or over five years. If it accepted a five-year payment plan, the district could either make principal and interest payments of $94,010 annually or principal-only payments of $87,593 annually followed by a single interest payment of $32,086.

None of these payment options worked for HFPD which receives only about $636,000 of the County’s property tax levy each year and has been paying CalPERS less than $30,000 annually. But the board found an alternative:  it obtained a 15-year loan from Five Star Bank, a local lending institution. Although the interest rate on this loan is relatively high — 5.81 percent with potential increases after the 5^th and 10^th year — the annual payment is a more affordable $46,777.

So, after much time and expense, HPFD has found its way out of CalPERS. As Liebig told me, the district probably never should have joined the system in the first place, but the 1995 board probably did not understand all the implications. CalPERS may just be too complicated and costly for small fire districts and other small agencies. Membership precludes the informal employment options that these governments may need to stretch their limited budgets.

Perhaps such districts could function effectively in CalPERS by merging, but this can mean a loss of local control valued by many voters. A better alternative is to provide these agencies with a simpler, more affordable off-ramp if and when that becomes necessary.