Analysis of the California Public Employees’ Pension Reform Act of 2013 (PEPRA)

Policy Brief

Analysis of the California Public Employees’ Pension Reform Act of 2013 (PEPRA)

PEPRA failed to substantially reform Californiaâ??s pension systems

The state of California and its local governments are saddled with unfunded public pension liabilities estimated to be as high as $583 billion. As a result, several municipalities in the state now have the difficult task of balancing budgets in a way that is fair to both public employees and taxpayers, while continuing to provide basic services. Indeed, public pension debt has contributed to the bankruptcies of the cities of Stockton, Vallejo and San Bernardino and has left other municipalities, such as Desert Hot Springs, in dire fiscal straits.

In response, state legislators on both sides of the political aisle passed the California Public Employees’ Pension Reform Act of 2013 (PEPRA) to address unfunded public pension liability.

This brief provides an overview of PEPRA’s key features, analyzes the weaknesses of the law, and offers recommendations for substantive reform of California’s public pension systems.

Weaknesses of PEPRA

Negligible Impact: The shortfalls California pension funds face are much larger than the modest savings PEPRA provides. Estimates peg California’s unfunded pension liability between $130 billion on the low end and $583 billion on the high end, not including the state’s estimated $150 billion dollar retiree health care liability. Compared to those liabilities, the $20 billion or so in present value savings over 30 years (at the high end of CalPERS and CalSTRS estimates) is a small percentage. Moreover, some of the reforms-such as the changes to benefit formulas, capping and defining pensionable compensation, and averaging final compensation over three years-will reduce costs and future unfunded liabilities, but those provisions have very little impact on the existing unfunded pension liabilities. As pension analyst John Dickerson puts it, “PEPRA tries to prevent fires two decades in the future but completely ignores today’s debt firestorm.”

Too Many Employees Are Exempted: PEPRA’s narrow definition of “new employee” leaves significant potential savings for employers on the table. As well, whole swaths of pension systems are exempt. Such exemptions dilute the impact of PEPRA in solving the unfunded liability problem.

Excessive OPEB (Other Post-Employment Benefits): While PEPRA creates new tiers for both safety and non-safety employees with lower benefits, PEPRA’s pension benefit adjustments do not go far enough. Many public employees in California have been promised health coverage for life, one of the major components to other post-employment benefits (OPEB), even though state and local governments are not setting aside the funds required to cover these future obligations. An April 2014 report found an unfunded retiree health care liability of $157.7 billion.

Overuse of “Safety Employee” Designation: The benefits received by safety members are greater than those of regular public employees, but these more generous benefits should be limited to employees who work in risky and dangerous situations protecting people from physical harm. In 1960, approximately 1 in 20 workers in California were classified as peacekeepers. By 2004, that number grew to 1 in 3. The term has become so vague that by 2008, over 60% of the California Union of Safety Employees included non-peace officers, such as milk inspectors, billboard inspectors, DMV drive test employees, lab technicians, smog-check employees and dispatchers.

No Taxpayer Representation on the Board: PEPRA failed to make any structural changes to the composition of the state pension boards that would provide for professionalized governance instead of the current bodies that are otherwise politically motivated and function with little finance or investment experience. As it now stands, government employees, retirees and politicians who have incentives to approve benefits beyond what the system can handle and are possibly be directly financially affected by board actions comprise CalPERS and CalSTRS boards. Rather than build a system that is affordable, sustainable and secure, the boards’ (as currently structured) main goals are to maximize their benefits and reduce costs of members.

Policy Recommendations

Though PEPRA moved the state on a more prudent path, its elected officials failed to make substantial reform to California’s pension systems sustainable for both employees and taxpayers. Substantive pension reform in California should include elements such as:

  • Creating a defined contribution plan or defined benefit/defined contribution hybrid pension plan for new employees.
  • Providing better taxpayer representation and more investment and financial expertise on the CalPERS board.
  • Enacting measures to pay down California’s existing unfunded liability quicker, such as switching to a level dollar amortization schedule and requiring higher employee contributions for new and current employees.
  • Addressing the “California Rule” allowing the state and municipalities to modify future pension benefits for current public employees.
  • Narrowing “safety employees” classification for employees who are regularly performing their duties at great risk and in harm’s way.
  • Expanding PEPRA’s limitations on post-retirement employment to all CalSTRS retirees, public safety workers and judges who are currently exempt from the rule.
  • Basing final compensation on an average of three to five years of highest years’ salary.
  • Defining pensionable pay as “the normal monthly rate of pay or base pay” for all employees.
  • Limiting special compensation categories from counting toward pensionable pay by significantly narrowing CalPERS’s list of special compensation, which has not been revised since 1993.
  • Freezing cost-of-living adjustments until CalPERS and CalSTRS are 100% funded.
  • Including public transit employees as a part of any substantive pension reform bill.
  • Classifying any employee who leaves the state pension system for the private sector, and returns after more than a year as a “new employee.”

PEPRA does not include any of the recommendations referenced above and addresses only four of the 12 points in Governor Jerry Brown’s original plan for California pension reform. Potential cost-saving measures in the governor’s plan left out of PEPRA include changes to the CalPERS board, changes to the retiree health care benefit system, and the inclusion of a defined benefit/defined contribution hybrid pension plan for new employees.

Failing to address the current pension unfunded liabilities in California is a significant weakness in PEPRA, and ignoring the debt pressure pension costs have on other budget priorities reduces the impact of the well-meaning reforms in the bill.

It is in the interest of all Californians to encourage a public pension law that provides a fair, workable plan to pay down the accumulated pension debt as quickly as possible and implements processes and practices that ensure both the state and local governments adequately fund their retirement promises.

Attachments

Victor Nava is a policy analyst at Reason Foundation, where he researches public sector pensions, federal and state economic policy, and crony capitalism.

Lance Christensen is the former director of Reason Foundation's Pension Reform Project.