RPVCCA_CC_SR_2011_09_06_01_Pension_RevisionMEMORANDUM
TO:CITY COUNCIL
FROM:MAYOR TOM LONG AND COUNCILMAN STEFAN WOLOWICZ,
PENSION REVISION SUBCOMMITTEE
DATE:
SUBJECT:
SEPTEMBER 6,2011
PENSION REVISION
RECOMMENDATION
Approve the recommendations made by Management Partners,Inc.lCity Council
Pension Revision Subcommittee regarding revisions to the City's pension program for
current employees and.new hires,and provide further direction to staff.
DISCUSSION
The City engaged Management Partners to provide an objective look at pension
benefits provided in the California local government setting and to identify what options
are available to modify the City's current retirement system for greater sustainability,
while continuing to meet service demands in the most efficient and effective manner
possible.Working with the City Council Pension Revision Subcommittee to identify
parameters,the consultant reviewed and analyzed City staff's assumptions and
calculations;surveyed competitor cities'retirement benefit plans;researched pensions
modifications being considered by CaIPERS,the State Legislature and public agencies
throughout the state;and researched retirement laws and regulations.The results and
the consultant's/subcommittee's recommendations are presented for the City Council's
consideration in the attached white paper.
Attachment:
Rancho Palos Verdes Pension Revision White Paper,Management Partners Inc.,
August 2011
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Pension Revision White Paper
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MANAGEMENT PARTNERS
INCORPORATED
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August 31,2011
Ms.Carolyn Lehr
City Manager
City of Randlo Palos Verdes
30940 Hawthorne Boulevard
Rancho Palos Verdes,CA 90275
Dear Carolyn:
Management Partners is pleased to transmit a draft of the Pension Reform White Paper for the
City of Ranmo Palos Verdes.In developing this paper we met with the City Council Pension
Revision Subcommittee;reviewed and analyzed City staff's assumptions and calculations;
surveyed competitor cities'retirement benefit plans;researched pension modifications being
considered by CaIPERS,the State Legislature and public agencies throughout the state;and
researched retirement laws and regulations.TI,ese efforts were undertaken to determine:
1.What options are available for the City?
2.What options would the City be precluded from pursuing either on legal,technical or
practical grOlmds?
3.What are the grey areas and uncertainties that must be confronted as the public pension
environment shifts?
This paper answers these questions and should help City decision-makers to approacll the
discussion about what,if any,cllanges to propose in the current retirement system armed with
full information about the state of the industry with respect to such programs..This paper also
provides options and recommendations to allow the decision makers to determine what
direction will best position the City of Rancho Palos Verdes to continue meeting service
demands in the most efficient and effective way possible.
Sincerely,
#L~~
Andrew S.Belknap
Regional Vice President
2107 North First Street Suite 470
San Jose,CA 95131
www.managementpartners.com 4084375400
Fax 453 6191
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Table of Contents
Table of Contents
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Introduction 1
Parameters :3
Distinction Between Defined Benefit and Defined Contribution 4
Background 6
Retirement Benefits in the Local Government Sector 6
Rancho Palos Verdes'Retirement Plan History 7
Chronology of Rancho Palos Verdes'Pension Revision Subcommittee Activities 7
Revision Efforts 9
City of San Jose Ballot Measure 9
Californians for Fiscal Responsibility Initiative 10
State Legislature Bills 11
Initiative process 13
CalPERS Position on Reform Efforts 13
Rancho Palos Verdes Data and Assumptions 15
Turnover Rate 15
Salary Increases 15
Projected Savings 15
Employee Retention :16
CalPERS Contribution Projections 16
Observations and Options 18
Retirement Formula 18
Final Compensation Calculation Basis 20
Employer-paid Member Contributions 20
Retirement Spiking 20
Current Options Compared with New Employee Options within Subcommittee
Parameters 21
Options for Consideration 22
Recommendations 24
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Current Employees ~24
New Hires 25
Current Employees and New Hires 26
Appendix A -First Pension Subcommittee Report 27
Appendix B-Second Pension Subcommittee Report.28
Appendix C -Third Pension Subcommittee Report 29
Appendix 0 -Vested Rights of CalPERS Members 30
Tables
Table 1.
Table 2.
Table 3.
Figures
Figure 1.
Figure 2.
CalPERS Rates under Various Scenarios 17
City Discretion with Changes to Basic CalPERS Attributes 22
Peer Comparison 23
CalPERS Investment Returns'17
Percentage of Compensation Under Various Plans 19
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Introduction
Introduction
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The City of Rancho Palos Verdes (RPV)engaged Management Partners to
provide an objective look at pension benefits provided in the Califorrua
local government setting.This was undertaken with a focus on how
plans are being modified to be fiscaIly sustainable over the long term in
the current economic environment while still providing competitive and
reasonable benefits so cities can recruit and retain the experienced staff
they require.Management Partners has reviewed changes being
considered by some jurisdictions such as the San Jose baIlot measure.We
have also reviewed and considered the changes proposed by the
Californians for Fiscal Responsibility initiative as weIl as other initiatives
and d1anges proposed by and being considered by the Legislators.
Management Partners does not consider these potential changes as viable
to Rancho Palos Verdes at this time.These changes are likely to face legal
chaIlenges and lead to prolonged and costly litigation.Additionally,
many of the changes require legislative action and/or changes in the law
or the State constitution.These d1anges are not available to Rancho Palos
Verdes at this time and,therefore,are not included in the
recommendations section of this paper.Should any of these changes
survive the legislative process and subsequent litigation and be found
legal,the City retains the option of adopting them at that time while
avoiding the cost of litigation.
Most cities in California contract with the California Public Employee
Retirement System (CaIPERS)for the provision of pension benefits and it
is one of the largest such organizations in the world.Currently CalPERS
serves 284 public agencies and has about 1.6 million members who are
public employees,retirees or beneficiaries.It manages approximately $1.7
billion in assets.
The costs associated with providing pension benefits through CalPERS
have climbed substantiaIly in the last several years.This is due to losses
sustained in agency investn1ents (such as stock market losses)and
enhancements granted in pension programs,primarily in the late 1990s
and the early 2000s.The most often cited enhancement was the creation
of a "3%at 50"program for public safety workers that can result in a
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Introduction Management Partners
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pension equal to about 90%of final compensation after a normal 3D-year.,
working career.As a result,CalPERS has had to increase payments
demanded of its contract agencies,particularly those agencies that have
adopted enhanced plans.
Increased payments are being demanded just as the resources available to
local govenunents have suffered severe setbacks.As a result,cities have
had to reduce expenditures and services to fund increasing pension costs.
This takes place against a backdrop of great economic uncertainty and in
an era in which defined benefit plans such as CalPERS have largely .
vanished from the private sector.Instead,defined contribution plans
have become more commonplace.111ey typically pay a lower benefit and
have much greater uncertainty than defined benefit programs.Rancho
Palos Verdes has not suffered revenue declines,does not have
responsibility for funding public safety pensions,and has not yet had to
reduce services to deliver pension benefits.Nonetheless,the city council
has sought to modify pensions to assure that Rancho Palos Verdes avoids
financial difficulties in the future and to stabilize pension costs as a
percentage of payroll.
As a result of pension cost increases,Rancho Palos Verdes,like many
other cities,is looking at options for changing existing CalPERS pension
benefits.A number of California cities have already introduced lower
benefit plans for new workers and raised contribution levels for existing
employees.
Rancho Palos Verdes is seeking a retirement plan that is sustainable in
the long term.In this case,sustainable is defined as a pension structure
with predictable expenditures that are generally a flat percentage of
payroll and that are both economical to the City and beneficial to
employees.The inability to achieve a sustainable pension structure may
result in the need to divert an increasing amount of general fund dollars
to pay for retirement benefits.111is would require a reduction in City
payroll through a reduction in the number of City employees,the
elimination of City programs and/or a general reduction in the quality,
frequency and number of services provided to the public.111e City is
understandably concemed about costs,while also conscious of the fact
that it needs to remain an employer that can recruit and retain employees
in the public employee labor market.
To develop options for the City,the Pension Revision Subcommittee
needs a solid analysis of basic facts regarding pension issues.This white
paper was created to examine the following issues:
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Introduction Management Partners
1.What options are available for the City?~
2.What options would the City be precluded from pursuing either
on legal,teclmical or practical grounds?
3.What are the grey areas and uncertainties that must be confronted
as the public pension environment shifts?
The paper objectively presents the current public pension environment
and reform efforts,City pension assumptions,information about how
peer organizations structure their plans,and finally,alternatives and
recommendations for Rand10 Palos Verdes leaders to consider.
Parameters
At the start of this engagement the City's Pension Revision Subcommittee
established the following parameters to be used when evaluating
alternatives for pension structure changes.
•Long term sustainabilitv.The City is seeking to modify pensions
to assure that Rancho Palos Verdes avoids financial difficulties in
the future by ensuring that pension expenditures become a
predictable and generally flat percentage of payroll and that the
pension system remains economical to the City and beneficial to
the employees.
•Maintain the ability to attract and retain quality emplovees.To
continue to utilize high-quality staff to provide excellent service to
residents,it is important for the City to provide a pension system
that is competitive with other jurisdictions competing for the same
employees.
•Avoid significant litigation risk.Litigation is costly and lengthy
and tl1e City does not wish to incur unwarranted costs in
reforming its pension plan.Once the courts have made rulings on
litigation over changes made by other jurisdictions,and/or if tl1e
State Legislature enacts d1anges that provide more options for
pension reform,the City has the ability to adopt those c11anges
determined to be legal and desirable.
•Provide protection against any possible retirement spiking.The
City wishes to preclude tl1e actuality of pension spiking but also
any appearance or perception of spiking.
•Maintain the Citv's non-participation status with respect to Social
Security.Social Security is intended to be a safety net by
redistributing wealtl1 and is neither economical nor cost-effective
as a means of delivering pension benefits to a primarily
professional workforce such as that tl1e City employs.It provides
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far less value for its cost than is provided by pensi~n benefits.
The City wishes to maximize the use of its funds and provide a
superior benefit for employees.
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Distinction Between Defined Benefit and Defined Contribution
Two basic categories of retirement plans exist:defined benefit plans and
defined contribution plans.A defilled benefit plan is a guaranteed annual
pension (benefit)based on retirement age,years of service and salary.
The employer contribution is a variable amount actuarially determined as
sufficient to provide the guaranteed benefit.A defined contribution plan is
one in which the employer contribution is a fixed amount.The benefit is
a variable based on investment earnings from the fixed contribution offset
by expenses.If the City wished to move from a defined benefit (DB)plan
to a defined contribution (DC)plan,the following issues would need to
be carefully weighed.
First,a defined contribution plan is not available within CaIPERS;
therefore,the City would have to establish its own defined contribution
plan outside of CaIPERS.Such plans have their own costs,including
administration costs.The City of Irvine had a DC plan several years ago,
but they moved into CalPERS in the early 2000s after determining that it
was less costly and less burdensome.
The City of Rancho Palos Verdes originally contracted with CalPERS and
remains Witll them due,in part,to legislative rules in terms of the State
Constitution and Government Code that make alternatives not feasible.
The cost of leaving CalPERS is substantial.The Ci ty would be required to
pay an amount to CalPERS to fund its liability for retirees.The amount of
this liability charge would have to be negotiated with CalPERS and
would include possible later increases in liability because of reciprocity
affecting final average compensation of future retirees.Although it is not
possible to estimate this cost without a full actuarial study,the cost
potentially would be large.In essence,the City would be selling its share
of CalPERS assets at a bad time to do so.Other termination costs would
also apply.
A related issue is whether the City could remain in CalPERS for current
employees but exclude future employees and,instead,put them in a
separate,defined contribution plan.We are unaware of any jurisdictions
that have done this.Aside from the administrative cost issues related to
offering a defined contribution plan discussed above,CalPERS has stated
informally,that its position is that agencies cannot keep current
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employees in CalPERS while excluding new hires.Manag.ement Partners'
reading of the City's contract with CalPERS is that it prohibits any such
exclusion of new employees.
Sections 20502 and 20303 of the Government Code appear to support the
ability of an agency to exclude new employees from CaIPERS.However,
CalPERS would probably challenge such an exclusion and,given the
City's stated desire to avoid costly litigation,we do not recommend that
the City take this path.
Given the current legislation and lack of alternatives,Management
Partners believes the costs and risks associated with moving from a
defined benefit to a defined contribution plan far outweigh any potential
benefits.We recommend that the City reform its defined benefit plan at
this time and retain the option of moving to a defined contribution plan
in the future if economic conditions,the job market and legislative
changes provide a more sound basis for such a move.
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Background
Background
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Retirement Benefits in the Local Government Sector
The California Public Employees Retirement System began operation in
1932 as the retirement system for state employees.In 1941,CaIPERS first
began contracting with public agencies and school districts.CaIPERS is
the largest public pension fund in the country with over $217 billion in
assets.As of June 30,2010,1,568 agencies with 1.6 million members
contracted with CaIPERS.
Public sector agencies in California have historically packaged relatively
modest compensation with more generous benefits,including a defined
benefit pension program.This was partially in recognition of the fact that
local government employees were not initially covered by Social Security;
many are still not covered -including those in Rancl10 Palos Verdes.Since
public sector employees obtained the right to collectively bargain in the
1970s compensation has become more competitive with private sector
levels.
Private industry has the choice of multiple pension administrators and
investment advisors to provide pension and investment services.TI1ese
alternatives are not financially feasible for California municipalities the
size of Rancl10 Palos Verdes.
General law cities and counties almost universally contract with CalPERS
for their retirement system.Based on CalPERS'statistics it appears that
approximately 85%of California cities are covered by this system.Some
charter cities and counties maintain their own retirement systems but this
is practical only for large cities and counties.To maintain its own
retirement system,an agency must establish a treasurer function and
must have the staffing and ability to invest funds to maximize returns.
Setting up and establishing investment systems is cost-prohibitive and
inefficient for small agencies.Agencies which elect to leave CalPERS are
required to pay significant termination costs to cover future retirement
cost liabilities.
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Most local government executives serve with multiple agencies during
their careers.It is,therefore,important to have the availability of
reciprocity (portability),provided by CalPERS for members who move
from one agency to another.
Rancho Palos Verdes'Retirement Plan History
The retirement plan provided to employees of Rancho Palos Verdes has
changed twice since the City first incorporated in 1974.The chronology of
the plan changes follows:
•On December 1,1974,the City of Ranchos Palos Verdes
established a 2%@ 60 retirement formula based on three-year
average final compensation
•On April 21,2001,the City changed to the 2%@ 55 formula
and went to the single highest year final compensation.
•On September 29,2007,the City changed to the 2.5%@55
formula while maintaining single highest year final
compensation.
The decisions to enhance the retirement formula in 2001 and 2007 were
based on surveys of cities'benefits with whom Rancho Palos Verdes
competed for talent.The changes were made to ensure that Rancho Palos
Verdes was able to attract and retain high-quality staff.Due to the
downturn in the economy as well as pension reductions made by
competitor cities,it is not currently necessary to offer the existing
retirement formula to attract and retain high-quality staff.
Chronology of Rancho Palos Verdes'Pension Revision
Subcommittee Activities
On November 4,2010,Council member Steven Wolowicz presented a
memorandum on Pension Revision to the City COlmcil,recommending
that the Council appoint a two-member subcommittee to work with City
staff to select a consulting firm to analyze and make recommendations for
a new retirement plan.Councilman Steven Wolowicz and Mayor Tom
Long were appointed to the subcommittee.
On ovember 30,2010,the Mayor and City Council members
participated in a Pension Workshop facilitated by CalPERS Senior
Actuary Kung-Pei Hwang and retirement plan consultant John Bartel.
On December 7,2010,the subcommittee presented its first report to the
City Council (see Appendix A).
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On January 18,2011,Bartel Associates,LLC submitted a r.\!port on the
City's CalPERS Unfunded Actuarial Accrued Liability (UAAL).
On June 7,2011,the subcommittee presented its second report (see
Appendix B).
On June 17,2011,Finance &IT Director Dennis McLean and Human
Resources Manager Eric Mausser presented a memorandum to the
subcommittee providing an update on the request for qualifications
(RFQ)and proposals for an independent retirement plan consultant to
analyze possible alternatives of the City's existing pension plan.
On July 1,2011,the subcommittee presented its third report to the City
Council (see Appendix C).
Management Partners has reviewed and researched the preliminary
findings of the subcommittee and have had those findings reviewed by
an attorney experienced in public pension law.We have determined that
these preliminary findings are valid and realistic.The California
Constitution and the regulations of CalPERS greatly limit the alternatives
available to public sector agencies in terms of pension benefit options.
The options that are available as well as various efforts by public agencies
and the legislature to increase those options through legislative
proposals,initiatives and ballot measures are discussed in detail in below.
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Revision Efforts
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Some local agencies have established a second tier of benefits for new
employees and greater cost-sharing by current employees.Both
approaches are possible through CaIPERS.There is some movement in
Charter cities to amend basic parameters in pension plans even for
existing employees,but there is great uncertainty about the question of
vested rights.
The City of San Jose is currently considering a Charter d1ange tl1at would
overhaul pensions for future as well as current employees.However,for
local agency members of CaIPERS,reform options are limited absent state
legislation.Any more significant change must,therefore occur at the
state level through the legislature or tl1rOllgh the initiative process in
order to allow greater flexibility to those agencies contracting with
CaIPERS.
111e following sections present current efforts to affect mange for public
sector pension options.
City of San Jose Ballot Measure
On May 13,2011,Mayor Chuck Reed,Vice Mayor Madison Nguyen and
Councilmembers Rose Herrera and Sam Licardo placed presented an
agenda item to the City Council recommending that the City:1)declare a
fiscal and public safety emergency,and 2)amend the City Charter to limit
retirement benefits and require voter approval of increases in retirement
benefits.The specific recommendations were as follows:
•For new employees,absent voter approval for enhancements or
increases,lin1it retirement benefits to a hybrid plan that may
consist of social security,defined benefits or defined contributions
with maximum City contributions in total being not less than 6.2%
or greater than 9%of base salary or 50%of the costs of tl1e benefits
whichever is less.
•For existing employees,without voter approval of enhancements
or increases,limit retirement benefits as follows:
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D Benefi ts earned and accrued to date would not be reduced.,
but additional pension benefits shall accrue at a maximum
rate of 1.5%per year of service.
D The age of eligibility for service retirement would be
increased by six months annually on July 1 until the
retirement age reaches the age of 60 for police officers and
65 for all other employees.
•For existing and future retirees,without voter approval of
enhancements or increases,institute the following changes:
o Limit increases in pension payments to retirees to the'-
increase in the Bay Area CP1,not to exceed 1%per year.
o Allow bonuses or other supplemental payments only to
long term service retirees or disability retirees whose
household income falls below the poverty level.
•Place additional limitations on growth in retirement benefits if the
fiscal and public safety emergency gets worse.
Four legislators asked the Office of State Attorney General to review the
San Jose emergency proposal.The response was that "unilateral
impairment"of any contract "causes us deep concern."This phrase
indicates that legal action would be taken against the City of San Jose in
response to this proposal.Rancho Palos Verdes and similar cities cannot
ignore such expected litigation costs.
Californians for Fiscal Responsibility Initiative
The Pension Revision Subcommittee requested that Management
Partners identify the provisions of the Fair and Sensible Public Employee
Retirement Plan Reform Act.ll1is initiative is sponsored by the nonprofit
organization Californians for Fiscal Responsibility.The stated provisions
of the Fair and Sensible Public Employee Retirement Plan 'Reform Act are
as follows:
•Aligns state and local government retirement benefits with those
offered by the federal government and large private employers.
o Employees hired after July1,2013 are eligible for a defined
contribution (DC)plan.
o Defined benefit (DB)pension for new employees will not
exceed the plan offered to federal workers on July1,2011
(1.1 %of highest three-year average at age 62 multiplied by
years of service).
o Qualifying compensation will not exceed 75%of taxable
social securi ty wages.
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o Defined benefits are payable when employ~es reach the
retirement age established by Social Security (currently age
62).
o Employees not covered by Social Security shall be
provided with a supplemental defined benefit equivalent
of social security.
o Public employees and taxpayers share costs.
o Current and future employees pay half tl,e cost of pension
and retiree health benefits.
o Defined benefits shall be based on an average of three-
years of qualifying compensation which excludes
overtime,sick,vacation,bonuses and severance .
o Retroactive benefit increases are prohibited.
o New employees may not receive lifetime medical benefits
prior to age 65.
o Improves efficiencies in benefit delivery.
o Disability benefits are provided by a joint powers
authority,self-insurance or private companies.
o Public employers shall provide competitive life insurance
and disability benefits integrated witl,retirement benefits
and other insurance.
o Public employees may opt out of their retiree health plan.
o Improves governance and accountability of public pension plans.
o Two-tllirds of a public pension plan's governing trustees
shall be independent of the retirement system and two-
thirds of independent trustees shall be certified or licensed
financial,actuarial,accounting,legal,benefits or
investment professionals.
State Legislature Bills
The unsustainable reality of current pension systems and associated
liability has resulted in numerous efforts by the legislature at reform.In
2010,two bilIs,AB 194 and AB 827 were passed by the Legislature but
then vetoed by the Governor.
AB 194 would have limited tl,e maximum salary upon which retirement
benefits are based to no more than 125%of the salary recommended by
tl1e California Citizens Compensation Committee for the position of
Governor.AB 827 would have prohibited an employment contract for a
local excluded employee from including any clause that provides for an
automatic renewal,an automatic compensation increase,or an automatic
compensation increase in excess of a cost-of-living adjustment.TI,e bilI
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would also have required local agencies to complete a performance,
review for any excluded employee before an increase in compensation in
excess of a cost-of-living adjustment may be implemented for that
individual.
So far in 2011,a number of Assembly Bills and Senate Bills have been
proposed that would make significant changes to pension structures.The
fate of these bills remains to be seen.Among these bills are:
o AB 344,which would place limits on final compensation and on
post-retirement employment.
o AB 646 which would prohibit a public agency from implementing
its last,best and final offer in bargaining until at least 10 days after
a fact finders'written findings of fact and recommended terms of
settlement have been submitted to the parties and the agency has
held a public hearing regarding the impasse.
o AB 875,which would prohibit public employees first hired on or
after January 1,2012 from using credit for accrued leave or
overtime for purposes of determining final compensation.
o AB 961,which would exclude matters relating to pension benefits
from the scope of representation of public employees,thereby
prohibiting employee organizations from negotiating pension
benefits with public employers.
o AB 1184,which would require the contracting agency from which
a non-represented CaIPERS member retires to pay that portion of
the liability for creditable service performed for a prior
contracting agency that exceeds 115%of the last salary paid by
that agency.It would also prohibit contracting agencies from
establishing t11eir own plans for individuals t11at first become
CalPERS members on or after January 1,2013.
o AB 1248,which would require a local public employer to provide
coverage under the federal Social Security system to all employees
who are not covered by a defined benefit plan.
o AB 1320,which would establish a Taxpayer Adverse Risk
Prevention Account for each CalPERS employer whose assets
would be invested Witll other CalPERS assets and be available to
pay employer retirement contributions that exceed the normal
cost of benefits.
o SB 27,which would provide that any change in salary,
compensation or remuneration principally for the purpose of
enhancing the benefits of a member (known as spiking)would not
be included in the calculation of the member's final compensation.
It would also prohibit any member who retires on or after January
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1,2013 from performing services for any employer covered by
their retirement system for 180 days..,
•S8 520,which would require CaIPERS to establish a hybrid
retirement plan for public employees who become members on or
after January 1,2013 and would prohibit those plans from creating
a vested property right for members with respect to any employer
contributions before retirement.
•S8 526,which would specify for employees hired on or after
January 1,2013 that final compensation means the highest annual
average compensation earnable during a consecutive 36-month
period of membership.The bill would also prohibit the addition
of compensation for accrued leave or overtime work in the
calculation of final compensation.
Initiative process
In addition to the bills moving through the Assembly and State Senate,
there is a state initiative called the "Public Employee Pension Reform Act"
(Initiative 11-0007)that would change the State Constitution and:
•Set the retirement age at 62 for current and new employees.
•Limit pensions to 60%of a three-year average salary.
•Require employees to match public agency retirement
contributions.
•Allow public agencies to modify pensions.
•Prevent pension changes through collective bargaining.
CalPERS Position on Reform Efforts
In July 2011,CaIPERS issued a paper titled Vested Rights of CafPERS
Members (included as Appendix 0).The document states:.
• A public employee's right to the retirement benefits earned during
employment is generally a vested right.
•Public employee retirement benefits are contractual obligations
entitled to the protection of the "Contract Clause"of the State
Constitution as well as provisions of tlle Federal Constitution
forbidding the impairment of contracts.
•Promised benefits may be increased during employment but not
decreased,absent the employee's consent.
•The courts have established that this mle prevents not only a
reduction in the benefits that have already been earned,but also a
reduction in the benefits tllat a member is eligible to earn during
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future service.This statement is particularly pertinent to the San.,
Jose ballot measure.
•Employees to be hired in the future do not have vested rights to
any particular retirement benefits and there is no constitutional
impediment to unilaterally reducing (or even eliminating)
retirement benefits for new hires.
•Some employers may choose to pay a portion or all of the
retirement contributions otherwise required of their employees.
These payments typically are negotiated during collective
bargaining and the law provides that the employer may
"periodically increase,reduce,or eliminate"such payments.
This paper suggests that CalPERS would go to court to protect the rights
of its members as outlined above.
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Rancho Palos Verdes Data and Assumptions
Rancho Palos Verdes Data and Assumptions
Management Partners
The following section of this white paper presents key data elements and
assumptions that contribute to retirement cost projections.
Turnover Rate
Rancho Palos Verdes staff assumes a turnover of two employees per year.
For the period of January 1,2005 through April 30,2011,turnover
averaged 2.8 employees per year.This equates to an average annual
turnover rate of 5%.This calculation does not include two employees
who were laid off during that period.
A 5%turnover rate projection is conservative as turnover will probably
increase when the economy improves.Additionally,a number of City
staff members are approaching retirement age which could also
accelerate the rate of hlrnover.As of this writing,City staff are re-
calculating a range of projected savings,using a low of two employees
leaving per year and a high of five leaving per year.Higher turnover will
result in additional savings for the City as current employees under the
2.5%@ 55 formula are replaced by new employees with a different
retirement tier (with a lower formula).
Salary Increases
Rancho Palos Verdes staff assumed annual salary rate increases of 3%
based on historical data (2.8%annual cost of living adjustment [COLA]
increases and 2.2%merit increases).Even though salary increases may
average less than 3%over the next six years,we are using that projection
as Management Partners does not want to overstate the savings which
will be higher if salary increases average less than 3%.
Projected Savings
If the City were to grant a one-time 5%pay increase in exchange for
employees paying the full 8%employer retirement contribution (instead
of paying 1.5%as they currently do),ill,d establish a 2nd tier witl,a
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Pension Revision White Paper
Rancho Palos Verdes Data and Assumptions Management Partners
.'.
2%@60 formula and three year average compensation basi~for new
employees,projected savings from current pension costs would range
between approximately $81,000 and $98,000 in year one based upon a
turnover rate of 5%and 7%,with increased savings each subsequent year
rising to approximately $347,000 to $478,000 in year six.111erefore,the
total pension savings over the initial six years would range between $1.2
million and $1.6 miIIion.Savings calculations based on lower average
salary increases and/or higher turnover will increase these projected
savings.
Employee Retention
An unintended consequence of the 2.5%@55 plan is that by having the
retirement formula top out at age 55,employees do not have an incentive
to remain employed beyond age 55 even though they may still have
much to contribute.In fact,many public employees,after reaching age 55
and retiring from a public agency,continue to work for another employer
or become self-employed.
The 2%@ 55 and 2%@ 60 formulas both reach their maximum percentage
(2.418%)at age 63.Under both of these formulas,employees have an
incentive to remain with the public agency beyond age 55 and up to the
more realistic retirement age of 63.
CalPERS Contribution Projections
Under U1e current 2.5%@ 55 formula with single highest year
compensation basis,and assuming an ongoing investment returns of
7.75%,CaIPERS projects the following employer contribution rates for the
next five years:
•2012/13 -13.8%
•2013/14 -15.5%
•2014/15 -15.8%
•2015/16 -16.1 %
•2016/17 -16.4%
These increases are not sustainable as defined by the subcommittee.111e
rate increases can be mitigated by moving to a second tier for new hires,
as illustrated in Table 1.CalPERS provided the foIIowing rates for new
hires under U1ree retirement plan scenarios.
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Pension Revision White Paper
Rancho Palos Verdes Data and Assumptions
Table 1.CalPERS Rates IIl/der Variolls Scenarios
Management Partners
Fiscal Year 2.5%@55 1-year 2%@55 3-year 2%@60 3-year
2010/11 10.263%8.475%6.755%
2011/12 13.353%9.539%7.733%
Figure 1 shows CaIPERS'historical inveshnent returns.
Figllre 1.CalPERS lnveshnel/t Retlll"lls'
15%
10%
5,·.,
·10%
_~'m,~•
•'"J'\"
1'\A,i·3%15.3~"~r~13bo%
./_..,....-.-
I ~O~1..:100.;~:!~~..:.1.;50.;I.n'..:.\1T5j UO''';1.50''':'I.~O''':'s.:!%I.:!!%I.:!!;'1.:5%9.:50.;u¥,7.750.;7.no.;7.750.;7;!0.;\7.W";~'r-m,•0.::1,0 V \/;%3.9%.
#\ofr J "It \,p @+,p ,p #,?<fJ-<S>01 #',p#~It~4',sP'"4''".7~~%·5.1 'k I
\
\
~
·2J.O%
Flsc.:!1 Ve.:!r
-Acluanal Inlerest Rale ~Annuill R4Jtes of Return -:!r 15-Year Rolling Geometric Averag
1 Source:Actuarial Presentatioll for the City of RnncJzo Palos Verdes by Kzwg-pei Hwnng,CalPERS Senior Pension
Actuary,11120110
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Pension Revision White Paper
Observations and Options
Observations and Options
Management Partners
.'.
It is neither practical nor feasible for the City to move out of the CalPERS
retirement system and into another system.Rancho Palos Verdes is a
General Law City rather than a Charter City.This alone severely limits
retirement system options.Even if the City could move out of CaIPERS,
there are no practical alternatives for a small city such as RPV.
Additionally,in order to move out of CaIPERS,the City would have to
pay a large "termination fee"to cover liability for future retirees,
pursuant to the existing agreement with CaIPERS.This is something the
City cannot unilaterally change.Given the realities of remaining within
the CalPERS system we looked at the options that are available to the
City within CalPERS.
There are three primary factors that determine the City's retirement costs:
•Type of retirement formula offered to employees,
•Final compensation basis that is used for benefit calculations,and
•Any portion of the employer retirement contribution that is paid
by the City (referred to as employer-paid member contributions
[EPMCJ).
An additional factor that may impact costs is whether employees have
the ability to increase the compensation basis during their final year(s)
of service ("retirement spiking").
Retirement Formula
City employees are currently under the 2.5%@55 formula.With this
formula,at age 55 an employee's retirement benefit is calculated by
multiplying the years of qualified service by 2.5%and then multiplying
final compensation by that percentage.For example,an employee 55 or
older with 25 years of qualified service would receive 62.5%of their final
compensation (2.5%x 25 years).Under this formula,the multiplier (2.5%)
does not increase after age 55.
Another formula commonly used by public agencies is the 2%@55
formula.Under this formula,at age 55 an employee's retirement benefit
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Pension Revision White Paper
Observations and Options Management Partners
.'.
is calculated by multiplying the years of qualified service by 2%and then
multiplying final compensation by that percentage.For e,;'ample,an
employee aged 55 with 25 years of qualified service would receive 50%of
their final compensation (2%x 25 years).With this formula,the
multiplier (2%)increases up to 2.418%at age 63 or older.So,an
employee who is 63 years old and has 25 years of qualified service would
receive 60.45%of their final compensation.
A third possibility that some agencies are begirming to implement for
new employees is the 2%@ 60 formula.With this formula,at age 60 an
employee's retirement benefit is calculated by multiplying the years of
qualified service by 2%and then multiplying final compensation by that
percentage.For example,an employee who is 60 and has 25 years of
qualified service would receive 50%of their final compensation (2%x 25
years).Under this formula,the multiplier (2%)also increases up to
2.418%at age 63 or older.So,an employee who is 63 with 25 years of
qualified service would receive 60.45%of their final compensation.Figure
2 below illustrates the different levels of final compensation under these
three plans at various ages.
Figure 2.Percentage of COll1peJlsation Under Various Plans
~2%@55
-D-2%@60
---:=-2.5%@55
2.500
2.418
2.5002.500
1.704
2.500
2.5
2250
-5 2.0 +-----,If'------:*.:'s,,-----Jlr-----
E<;...
~
"c:~1.5 4--"""-----.1.-"-----------
1.0 +-_---'-='---__---.J.-_--_--_-~
Additional years of service
50 52.5 55
I
57.5 60 63
RetirementAge
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Pension Revision White Paper
Observations and Options
Final Compensation Calculation Basis
Management Partners
.,
.'.
For current City employees,the final compensation basis is known as
single highest year.TI,e employee's single highest year compensation
(based on 12 consecutive months)is used in the benefit calculation.
Normally,but not always,the highest compensation occurs in the
employee's final year of service.
An alternate final compensation is known as three-year average.In this
case,the employee's highest average compensation over 36 consecutive
months is to calculate the benefit.Normally,but not always,the hignest
average annual compensation occurs in the employee's final three years
of service.
Employer-paid Member Contributions
CalPER5 has set the employee contribution for the 2.5%@55 plan at 8%
of salary.Of this 8%,the City currently pays 65%and employees pay
1.5%.TI,e current employer contribution rate for both the 2%@55 and
2%@60 plans is 7%rather than the 8%contribution rate for the 25%@5 5
plan.
For botl,current and future employees,the City could decide to pay all,
part,or none of tl,e employee contribution.So,for employees under the
25%@55 plan,the City could reduce its EPMC to 0%or any other
percentage with employees paying the remainder of the 8%employee
contribution.
The City also has the latitude to establish different EPMC percentages for
different plans.For example,the Ci ty could set a 0%EPMC for
employees under the 25%@55 plan with employees paying the full 8%
while setting a different EPMC percentage (e.g.,3%)for employees under
a 2%@55 or 2%@60 plan.
Retirement Spiking
As noted above,the retirement benefit is calculated by multiplying final
compensation by a percentage factor based on the employee's age and
years of service.Also,final compensation is based on either the
employee's highest 12 consecutive months of compensation or the
employee's highest average compensation over 36 consecutive montl,s.It
is in the City's interest,and in tl,e interest of taxpayers,to ensure that
employees do not manipulate their final compensation for the purpose of
increasing their retirement benefit.
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Pension Revision White Paper
Observations and Options Management Partners
.'.
One way in which spiking can occur is to promote an employee at the
end of their career or explicitly to increase their final comp~nsation.
Otl1er forms of increasing salary include special assignments t11at pay a
differential or acting pay.The City should be diligent in reviewing any
such late career salary increases to ensure they are based on need and are
in the best interests of the City and that t11ey are not being implemented
to increase final compensation for retirement purposes.
CaIPERS has instituted a number of regulations to limit opportunities for
retirement spiking.For example,EPMCs are not counted in final
compensation by CalPERS unless an agency specifically elects to do so
through a memorandum of agreement or ordinance.Employer cash-outs
of accrued but unused vacation and sick leave are also now excluded
from final compensation by CalPERS.CalPERS does allow unused sick
leave to count toward additional service credit (but not toward final
compensation).For every 250 days (2,000 hours)of unused sick leave,the
employee is credited with one additional year of service.This credit is
mandated for pooled agencies such as Rancho Palos Verdes.CalPERS
estimates the cost this benefit as 0.2%to 0.7%of payroll depending on the
amount of unused sick leave accrued by employees upon retirement.
Current Options Compared with New Employee Options within
Subcommittee Parameters
The following applies to current employees:
•Cannot change formula
•Cannot change compensation calculation basis
•Can change EPMC
Additionally,the City could provide a voluntary deferredcompensation
plan with or without the City making a contribution to assist in retaining
employees who reach the current retirement age of 55.111is option has
not been fully studied by Management Partners or by t11e subcommittee
and is not part of our recommendation.However,we do recommend
that it be studied further in the future.
111e following applies to new employees:
o Can change formula
o Can change compensation calculation basis
o Can change EPMC
Additionally,the City can provide a voluntary deferred compensation
plan with or without the City making a contribution.
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Pension Revision White Paper
Observations and Options Management Partners
.'.
Table 2 below summarizes the City's ability to change basic attributes•associated with the CalPERS plan based on current legal understandings
and CalPERS positions.
Table 2.CihJ Discretioll with Ch01lges to Basic CalPERS Ath·iblltes
Current New
Retirement Component Employees Employees
Change to pension formula Cannot change Can change
Change to compensation calculation basis Cannot change Can change
Change to employer paid member contribution Can change Can change
Options for Consideration
The following options could be considered by City Council.
•Adopt alternative CaJPERS formulas for new hires
o 2%@55
o 2%@60
•Institute a three-year salary basis for new hires
•Modify EPMC for new hires and/or current employees
•Offer a deferred compensation plan supplement for 2%@55 or 2%
@60 plans
Approaches utilized by benchmark cities are presented in Table 3.
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Pension Revision White Paper
Observations and Options
Table 3.Peel'Comparisoll
Management Partners
.'.
Employer Employee Employer Paid Total
Retirement Contribution Contribution Member Employer
Peer City Formula Salary Basis to PERS to PERS Contribution Contribution
6.5%-employee
RPV 2.5%@55 Single highest year 15.1%8.0%pays l.S%21.6%
0%-employee
pays 7%but City
RPV contributes 1%·
Proposed Average of three 1.5%to Deferred 7.755%to
Tier 2 2%@60 highest years'salary 6.755%7.0%Camp Plan 8.255%
Single highest year
2%@55 July 1,2011 Average
Rolling Hills July 1,2011 of three highest 0%-employee
Estates!2%@60 years 20.5%7.0%pays 7%2 20.5%
Average of three 7%-employee
Calabasas 2%@55 highest years'salary 10.9%7.0%pays 0%17.9%
laguna Average of three 7%-employee
Niguel 2%@55 highest years'salary 10.539%7.0%pays 0%17.539%
Classified:less
than two years
of service
4.47%
contribution;Classified staff for
after two first two years:
years of 3.6%-employee Classified:
Classified:service 6.26%pays 0.87%33.37%
27.11%contribution.
Classified after
Management:Management:two years,Management:
27.11%5.01%Management,32.12%
Executive:City
Sanjuan Average of three Executives: Executives:pays 100%of Executive:
Capistrano 2.7%@55 highest years'salary 27.11%7.74%employee's share.34.85%
5.25%-employee
Goleta 2%@5S Single highest year 10.338%7.0%pay 1.75%15.588%
La Canada 7%-employee
Flintridge 2%@55 Single highest year 12.73%7.0%pays 0%19.73%
Data not Data not Data not
Malibu 2%@55 Data not available available available Data not available available
7%-employee
Walnut 2%@55 Single highest year 11.751%7.0%pays 0%18.751%
J Cihj implemented Tier 2 (2%@60with three-year average)711/11.
2 A olle-time 7%salary illcrease was provided as all offset.
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Pension Revision White Paper
Recommendations
Recommendations
Management Partners
-,
'.
Based on the parameters identified by the Pension Revision
Subcommittee,analysis of available options,and review of peer
jurisdiction systems,Management Partners offers the following
recommenda tions.
Current Employees
11,e City should retain the 2.5%@55 formula and retain the single-
highest year basis.In addition,Management Partners recommends that
the City:
•Decrease EPMC from 6.5%to 0%.
•Grant a one-time 5%salary increase in conjunction with
increasing the employees'portion of retirement contribution from
1.5%to 8%.1his results in a net savings to the City of 1.5%of
payroll in year one and in each subsequent year.
Note:Prior to 2007,the City paid the entire employee retirement
contribution and employees paid no portion of the contribution.In 2007,
Ci ty employees were asked to vote on whether to increase their
contribution from 0%to 1.5%in conjunction with improving the
retirement formula from 2%@55 to 2.5%@55.The employees voted to
do so.
Although we believe the City has a good legal basis to reduce the EPMC
for current employees,City employees might take the position that since
they voted on setting the EPMC at 6.5%,the 6.5%EPMC is a vested right.
This specific issue is untested in litigation.To minimize the costs of
potential litigation,we recommend that the one-time 5%salary increase
be implemented to partially offset the 6.5%EPMC reduction.1his offset
will greatly reduce the potential of litigation alleging that the 6.5%EPMC
is a vested right.
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Pension Revision White Paper
Recommendations
New Hires
Management Partners
.'.
\'
Management Partners recommends that the City change to 2%@60
formula.In addition,we recommend that the City:
•Change to three-year average basis.
•Institute EPMC of 0%with employees paying the full 7%
employee contribution.
•Offer an optional deferred compensation plan [401(a)or 457(b)
plan]with the City contributing up to 1%or 1.5%to new
employees who elect to participate in and make contributions"to
the plan.In the interest of fairness and practicality,once
established,the 1%to 1.5%City contribution amount should
remain at that level unless it is necessary to change it due to
severe and unanticipated financial circumstances.
Note:The cost to the City for the 2%@60 plan with a matching 1.5%
contribution to a 457(b)plan is slightly less than the cost of the 2%@55
without any matching.Since bOtll plans "top out"at 2.418%at age 63,the
benefit to employees who work until age 63 is significantly greater under
the 2%@60 plan with the 1.5%match than under the 2%@55 plan
without the matdl.
Moving the age at which the retirement formula "tops out"to 63 has
benefits for both the City and its employees.The City will retain
experienced employees beyond the current retirement age of 55 while
also reducing recruitnlent and training costs for senior level positions.
Employees who retire at age 63 rather than the current age of 55 while
enjoying a City contribution into a deferred compensation play will enjoy
a more secure retirement in several ways:
By working for the City to age 63 rather than age 55,employees
will retire with more years of service which is a major factor in the
retirement benefit.Since employees who retire from tlle City at
age 55 often continue in employment elsewhere,the employee's
work years will,in many cases,remain the same.
The 2.5%@55 tier has a maximum benefit of 2.5%while the 2%@60
tier has a maximum benefit of 2.418%(less than 0.1 %difference).
The cumulative effect of the City's deferred compensation
contribution of 1%-1.5%over the course of employees'careers
more than makes up for tlle minor difference in the maximum
formulas in the two tiers.
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Pension Revision White Paper
Recommendations
Current Employees and New Hires
Management Partners
.,
.'.
Management Partners recommends that the City closely review and limit
any final year compensation increases to preclude spiking.
Under these recommended reforms,the City will achieve immediate first
year savings of 1.5%of payroll.Absent any current staff leaving the City,
ongoing annual savings of 1.5%will be realized.Significantly higher
savings will be achieved as current employees who are under the 2.5%@
55 formula are replaced by new employees under the 2%@ 60 formula .
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Pension Revision White Paper
Appendix A -First Pension Subcommittee Report
Appendix A-First Pension Subcommittee Report
27
Management Partners
1-32
'.
First Report of the Pension Subcommittee of the City Council for the City of
Rancho Palos Verdes
Members:Stefan Wolowicz and Thomas Long
Initial Meeting:December 7,2010
Although the subcommittee anticipates conducting additional meetings and working with
an independent consultant to attempt to formulate one or more proposals for possible
pension revision to be considered by the city council as a whole,the subcommittee felt it
would be useful to issue a set of preliminary observations and common agreements -
under which the subcommittee is working for the purpose of providing information to
those interested in the subcommittee's work.These observations and common
agreements are subject to revision if the independent consultant presents information
not currently known or considered by the subcommittee.
Observations:
A.The average benefit collected from the City of Rancho Palos Verdes pension
plan by retirees is approximately $1 ,000 per month.Rancho Palos Verdes
employees do not eam Social Security benefits based on their time with the City.
According to the speakers at the December 7,2010 meeting the City's pension
benefits are about average when compared to those offered by other comparable
cities.
B.Funding the City's pension benefits,even after significant investment losses have
required large increases in contributions,consumes about 3%of the City's
general revenue budget.Protective service employee pension costs are not
under the control of .the city council.Fire Department pensions are under the fire
department's budget within the County of Los Angeles.Sheriff Department's
pensions are under the control of the Sheriff.Although the City contracts with the
Sheriff to provide police services,the City has no control over the Sheriffs
pension policies.
C.Prior to the initial subcommittee meeting the City Manager relayed a concern
expressed by Staff that included in the concept of "vested benefits"is the
percentage of employees'portion of contribution.While the core elements of the
existing employees plan should not change,the discretionary latitude of this
percentage needs to be clarified and understood.Moreover the independent
con.sultants may identify other factors that are not now known for consideration.
D.The subcommittee was established by the Council to address concems
expressed by council members about the City's rising pension costs both in
terms of absolute dollars and as a percentage of covered payroll.The
subcommittee was also tasked to consider the potential impact,if any,of
underfunding of vested benefits.
1
1-33
.'.
E.Various factors contribute to the complexity of the subcommittee's tas.ks and may
be beyond the control of the council and the City.These include:.
(1)Unpredictable and uncontrollable impacts on investments from market
performance and changes in actuarial factors that affect the costs of
benefits.
(2)CalPERS offers only a limited set of options.Based on comments from the
speakers dUring the December 7,2010 it is our understanding that
CalPERS does not provide service for Defined Contribution retirement
plans.CalPERS would require cities offering a second tier defined
contribution plan to place the defined benefit plan with another plan
administrator.
(3)Adopting changes to the City's pension plan that would reinstitute Social
Security benefits or adopt currentiy unavailable formats may require
agency rulings,judicial interpretations,and/or legislative action.
Common Agreements:
1.The subcommittee is considering changes in pension fonmulas,
contributions,and benefits only for newly-hired employees.The subcommittee is
not now considering any changes,whether it is in benefits or funding of contributions,
for existing employees and retirees of the City of Rancho Palos Verdes.
2.The subcommittee is not considering options which involve the City
departing from the California Public Employees Retirement System ("CaIPERS").
Given the preliminary comments received,the subcommittee has found that departing
from CalPERS is not now practical or cost-effective.
3.Any revisions made to the City's pension benefits should not
degrade the City's ability to recruit and retain high quality professional
employees.The City has a long established policy of attempting to provide
compensation at the 75 th percentiie when compared to other comparable Califomia
cities as a way of recruiting and retaining skilled employees.
4.The primary purpose of pension revisions is to control costs and to
provide a sustainable pension plan.It may be found that given viabie alternatives
now available retirement costs cannot be significantly reduced but only limited in the
increases.The purpose of pension revisions is not to cut pension benefits to existing
employees or otherwise disrupt the City's relationships with its employees or with
potential recruits.Instead,the purpose is to assure that pension contributions both
appropriately fund promised benefits but also are within the City's abilities to support.
Future pension cost increases should be controlled such that the City's overall pension
costs remain a relatively low share of the City's budget and do not grow
disproportionately compared to other of the City's costs.A sustainable pension plan
providing good value benefits is in the common interest of both the City's employees
and its residents.
,,
I·
2
1-34
.'.
5.Broader pension revisions are likely to be effective,if at al.l.only at a
higher government level.Members of the subcommittee and/or members of the
public may support different and more considerable revisions to pension benefits for
public employees.However,a broader scope of revision may not be possible at the
level of a City the Consultants will be asked to identify viable (practical and cost-
effective)altematives.Significant alternatives may be made available to municipalities
through action by the governor,legislature,ballot initiative,or new models developed for
municipalities.The current or future Councils should be free to consider those
alternatives as they arise.
As the subcommittee proceeds forward,it hopes to develop a consensus as to _
whether or not a viable revision to the City's existing pension program is necessary and
possible.If such a consensus in favor of a revision emerges,the subcommittee will
either reach a consensus on a single proposed option for a revision or perhaps two or
more options for the entire Council to choose among.We anticipate at least one
additional report summarizing the results of recommendations from the retained
independe'nt consultant and our additional work.
Dated January 4,2011
Sincerely,
401458JDOC 3
1-35
Pension Revision White Paper
Appendix B-Second Pension Subcommittee Report Management Partners
.L.
Appendix B-Second Pension Subcommittee Report •
28
1-36
'.
Second Report of the Pension Subcommittee of the City Council for the City of
Rancho Palos Verdes .,
Members:Stefan Wolowicz and Thomas Long
Date 7 June 2011
This report supplements the Subcommittee's earlier report of December 7,2010,a copy
of which is attached for your reference.T-he Subcommittee reaffirms the observations
and common agreements announced in its first report of December 7,2010.The
purpose of this report is to advise the Council,the City employees and the public of
further efforts by the Subcommittee since the time of our last report.
The Subcommittee is continuing to study options designed to assure that the City's
pension plan remains sustainable and practical.Based on Information gathered and ,'.",
pending meeting with an advisory consultant the Subcommittee has tentatively,i.'"i··'
concluded that the present range of options available to it is fairly limited.The ".".C'.'.'",'
Subcommittee tentatively does not expect to recommend that Rancho Palos Verdes ..,..•.,
leave CaIPERS.These tentative conclusions have been reached due to two primary:"...
reasons.First,the City is too small to bear the costs of maintaining its own pension:plan:,
and presently securing an altemative plan and sponsor does not appear viable,'
accordingly leaving CalPERS is ncit a viable option at this time.It is expected tllat .
ultimately major reform by the state legislature will be necessary to provide the 'levels.of...
changes now required by CALPERS.Second,the Subcommittee hopes to avoid,..
recommending changes to the City's pension that could pose a significant risk to the
City in litigation.
With the above restrictions in mind,the Subcommittee is continuing to work to develop a
consensus proposal to the Council for changes in the City's pension plan that will
bolster its sustainability by stabilizing the City's pension costs as a percentage of
payroll.The Subcommittee is exploring creating a second tier pension plan for new
employees.The Subcommittee is also exploring adjusting the contributions of current
employees toward the pension plan coupled with an equitable adjustment in the salaries
of current employees.Staff has presented the Subcommittee with a number of options
and predicted savings from each of the options.The Subcommittee needs additional
time to study these options and needs to confer with an independent pension
consultant.We hope to select and begin conferring with the independent consultant
within the following month.
In its first report,the Subcommittee indicated that it was planning to work with an
independent consultant.Staff promptly prepared a request for proposal but received
only one bid in response to that initial proposal.The Subcommittee felt it was
necessary to circulate a new proposal and to solicit additional bids.Through no fault of
the staff,the process of obtaining an independent consultant has,unfortunately,been
delayed.Nonetheless,the Subcommittee anticipates conferring with an independent
407722 1.dac
c:Id~"'~~77ZZ..1Jicc.1
1-37
'.
.,
consultant to confirm its own assumptions and the information that staff has provided to
it and developing a final report to the Council with either a consensus recommendation
or viable a~ernative proposals for the Council to consider within the next three months.
The Subcommittee attended a recent presentation of the Los Angeles Division of the
League of California Cities on Pension Reform.A handout containing some .
background information discussed at that meeting is also attached to this report.The
Subcommittee is providing this report and the attached information and will be prepared
at our meeting on June 7,2011 to respond to q,uestions by the Council.
Dated~7 ,2011
Sincerely,
r
'..
'.
1-38
Pension Revision White Paper
Appendix C -Third Pension Subcommittee Report Management Partners
.'.
Appendix C-Third Pension Subcommittee Report
29
1-39
.'.
Third Report of the Pension Subcommittee of the City Council
for the City of Rancho Palos Verdes
Summary of Meeting of July 1,2011
Members:Councilmember Steve Wolowicz and Mayor Tom Long
Consultants:Andy Belknap and Tim Sullivan,Management Partners,Inc.
The Subcommittee reaffirms its observations from its initial two reports.For ease of reference
those two reports are attached.
Goals of the project
o Consider recommendations to the Council for possible changes in RPV's pension
structure to assure long term sustainability that does not expose the City to risk of
litigation or deteriorated employee relationships.
o Provide the Subcommittee with advice and confirmation of issues that the
Subcommittee has encountered during the preliminary gathering of information.Also
include comments and advice as to the potential implementation or probable
roadblocks of the adoption of a defined contribution-type plan.
o Sustainability generally means ensuring that pension expenditures become a predictable
and generally flat percentage of payroll.
o Management Partners will assist the Council Subcommittee in reaching a
recommendation and will prepare further interim reports after each meeting with the
sub-committee.
o Present a final report to the City Council in September,ideally at the first meeting of
that month.
Areas to consider in formulating recommendations:
Given the preliminary information obtained by the Subcommittee,the Consultants are to
provide advice as to the expected viability of adopting an expected "second tier"defined
benefit plan for new employees.
o Whether to move from a singie highest year salary basis to a three year average saiary
basis.
o How to provide protection against any possible retirement spiking,by for exampie
converting vacation or sick leave into compensable pay for purposes of retirement
calcuiation
o Whether to offer a one-time S%salary increase in exchange for increasing employee
contribution from 1.5%currently as follows:
o Current employees pay 8%retirement contribution and stay in 2.S%@ SS plan
o Future employees pay 8%retirement contribution and move to 2%@ SS plan or
2%@ 60 plan.
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o Whether to offer a Second Tier Plan to current employees on a voluntary basis with
some incentive such as lower contribution rate or employer matching in a Deferred
Compensation plan.Also consider employer matching in a Deferred Compensation plan
generally for the possible Second Tier Plan.
o Determine how to ensure that any new pension plan does not require Social Security
coverage
Desired action items:
o Examine and comment on assumptions in the Subcommitee's two prior reports.
o Confirm staff's data as submitted to the Subcommittee and the Consultant.
o Determine the City's actual turnover rate for the past 10 years.
o Determine if the annuity percentage for 2.S%@ SS and 2%@ 55 even out at any age.
o Cite potential pension reform ballot issues (David Crane and Marcia Fritz or other
credible expected sponsors of pension reform initiatives likely to be proposed to
California voters)in the report.
o Explore the assumption and explain why it is not feasible or practical to move beyond
the concept of sustainability (i.e.,a defined contribution play).
o Establish the credibility of the data and numbers.
o Determine which cities to include in comparisons:
o Coastal contract cities without public safety employees
o Those with similar demographics
o General Law
o High cost of living
o Show the experience agencies with their own pension plans (e.g.,Orange County)have
had.
o Gather historical records of CalPERS contributions for unfunded future liability.
o Address the issue which some raise that pension reform must come from the State
level.
o Be able to say to staff,"Yes,these changes will cost you more but it will assure plan
sustainable.You don't want to be a member of a retirement plan that is not
sustainable."
o Also be able to explain the reasons that now exist which are likely and valid reasons
which now prevent discontinuation of defined benefit plans in favor of defined
contribution plans.
Questions to answer by the Consulting Advisors:
o If the City moves to a two tier plan (2.5%@ SS for current employees and 2%@ 55 for
new employees with all employees paying 8%retirement contribution)will they reach a
level percentage of payroll within 3-5 years?If not what would be a reasonable period
of time within which to reach a level percentage of payroll?
o Assess the uncertainties associated with CalPers including:
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o Variability /volatility of contribution rates?
o Unfunded future liability?Note:It is expected that the Advisors must be
prepared to fully explain the importance or lack of importance as·to this issue,
•What is the status of the iRS ruling on Orange County?
•For the possible new Second Tier Plan,is it possible to include a voluntary DC Plan (4S7
Plan)?
•Can a 2%@ 60 Plan be enriched by adding a deferred compensation component?
•Is it legal and otherwise advisable for the City to make contributions to a deferred
compensation plan based on age or years of service (as an incentive for staff to work
beyond age SS)?
• A critical and important part of the consultants'advice includes a full description of.all
viable,legal and practical alternative retirement plans which reasonably considered for
adoption by the City .
Timeline:
Develop a draft report for review by the Council Subcommittee,in advance of a final report
presentation for the September 6,2011 Council meeting.
1-42
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Pension Revision White Paper
Appendix D-Vested Rights of CalPERS Members
Appendix D-Vested Rights of CalPERS Members
30
Management Partners
1-43
.,
Vested Rights of CalPERS Members
Protecting the pension promises made
to public employees
July 2011
1-44
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,~-----------------------------------,
CalPERS Profile
The California Public Employees'Re<iremenr System (CalPERS)is the
nation's largest public pension fund with assets of appcoximatcly $240 billion.
Headquarcered in Sacramenco,CalPERS provides retirement and health
benefit services co morc than 1.6 million members and 3,033 school and public
employers.The System also operates eight Regional Offices located in Fresno,
Glendale,Orange,Sacramento,San Diego,San Bernardino,San Jose,and
Walnur Creek.Lcd by a 13-member Board of Adminisrrarion,consisring of
member-elected,appointed.and ex officio members.CalPERS membership
consists of approximately 1.1 miJJion active and inactive members and more
than 500,000 retirees,beneficiaries,and survivors from State,school and
public agencies.
Esrablished by legislarion in 1931,rhe Sysrem became operarional in
1932 for me purpose of providing a secure retirement to State employees
who dedicate their careers [0 public service.In 1939,new legislation allowed
public agency and classified school employees ro join the Sysrem for reriremenr
.benefits.CalPERS began administering healrh benefits for State employees
in 1962,and five years larer,public agencies joined rhe Healrh Program on
a COntracr basis.
A defined benefir reriremenr plan,CalPERS provides benefirs based
on a member's years of service,age, and highesr compensation.In addition,
benefits arc provided for disability and dearh.
Today CalPERS offers addirional programs,including a deferred
compensarion retirement savings plan,member education services,and
an employer rrust for post-retirement benefits.Learn more:ar our website
ar www.calpers.ca.gov.
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...
Contents
I.Introduction .3
II.Overview:Member Benefits And Contributions.. 4
III.Overview:Employer Funding Obligations.. 7
IV.California Contract Clause as Applied to Public
Employees'Retirement Benefit Rights . ........8
V.Federal Contract Clause as Applied to Public
Employees'Rights in California..12
VI.CalPERS Members'Rights ..13
VII.The Role of CalPERS in Protecting Members'
Vested Rights ..16
VIII.Conclusion .17
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2 I Vested Rights of CalPERS Members
1-47
'.
I.Introduction
.,
Recent economic crises affecring the world's governments and markers have brought fiscal
pressures on state and local budgets in California.Budgetary constraints have focused atten-
tion on the COSt of providing public services,and no COSt has received more attention than the
compensation and benefits earned by our public employees.Commissions,political leaders
and ptivate citizens all have weighed in on the subject,each proposing wide-ranging "reforms"
aimed at reducing the retirement benefits earned by public servants.Proposals have included,
for example:moving to less advantageous benefit formulas,imposing caps on pensionable
compensation,changing the definition of pensionable compensation to exclude items that are
currently included,lengthening the "final compensation"period on which benefits are calcu-
lated,restricting employees'rights to purchase additional service credit,lengthening eligibility
periods,increasing employee contributions and eliminating employer paid member contribu-
tions.Many of these proposals seek to apply these "reforms"to currently active employees as
well as those who may be hired in the future.
Understandably,this attention on the compensarion and benefits of members of the
California Public Employees'Rerirement System ("CalPERS")has raised concerns as to the
level of assurance the law provides that promised pensions will be available upon retirement.
CalPERS has prepared this paper for two purposes:
•To articulate the current state of California law regarding the nature of its
members'pension rights and the extent to which such rights have become
"vested"and may not be impaired;and
To explain the role of CalPERS in ensuring that its members'vested rights
are honored.
This paper is not intended to respond to any particular proposed legislation or initiative.
Rather,it is intended to present CalPERS'institutional views in the broader context of its
primary governing laws:the California Public Employees'Retirement Law (Gov't Code
§§20000,et seq.)(the "PERL")and the California and United States Constitutions.The
merirs and enforceability of any new proposal must be analyzed on its own unique terms
and conditions.
Finally,although some of the general principles and authorities discussed in this paper
may be relevant to plans CalPERS administers other than the Public Employee Retirement
Fund defined benefit plan,this paper is not intended to address any issues related to the
CalPERS'health benefits plans,defined contribution plans,the Legislator's Retirement
System or the Judicial Retirement Systems (I and II).
Vested Rights of CalPERS Members I 3
1-48
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II.Overview:Member Benefits And Contributions
California law clearly establishes that public employee tetirement benefits are a form of
deferred compensarion and part of the employment contracr.Righrs ra this deferred compen-
sation are earned when the employee provides service ra the public employer.
By statute and contracr,public employers,not CalPERS,decide how much of an
employee's compensation will be paid currently and how much will be deferred and paid in
the future.Simply put,employers grant the benefits owed ro CaIPERS'members.CalPERS
in cum serves as the trustee of the trust created to fund these benefits,through the prudent
administration and investment of the retirement fund.
The rights of all CalPERS members are established by stacute.In the case of local agencies,
members'rights are also governed by the contract between the agency and CalPERS.When
contracting with CalPERS,local agencies may choose from a menu of options.Benefits for
CalPERS members are often the product of collective bargaining.
This section provides a general overview of the core benefits earned by CalPERS
members.It is not intended ra be a comprehensive description of all benefits and rights
of all CalPERS members.
A.Service Retirement Allowance
Each CalPERS member earns service credit towards a lifetime retirement allowance after
employment,calculated under a formula which accounts for the member's years of credited
service,the member's "final compensacion"and the member's age at retirement.Each benefit
formula is commonly referred to as a specified percentage of a member's "final compensation"
for each year of service,based on a particular age at retirement.For example,under a "2%
at 55"benefit formula,a member receives 2%of his or her "final compensation"per year of
credired service,if rhat member retires at age 55.If the member retires earlier or later than age
55.the member receives a lower or higher percentage of"finaJ compensation,"according [Q
a stacurary table.For example,under the "State 2%at 55"table,a member retiring at age 50
receives 1.1 %of "final compensation"per year of credited service.A member retiring at age 63
'or older receives 2.5%of "final compensation"per year of credited service.
As noted,each formula applies a mulriplier to a member's "final compensation."For some
members."final compensation"means the highest one-year average pensionable "compensation
earnable"that they earn during their careers.For other members,the highest annualized three-
year average "compensation earnable"that they earn during their careers is used.In general
terms,"compensation earnable"includes the member's "payrate"(essentially base salary)and
certain items of "special compensation,"which are established as pensionable by law or regula-
tion."Compensation earnable"generally does not include items such as overtime pay and
amounts that are not available ra employees in the same group or class of public employment.
4 I Vested Rights of CalPERS Members
1-49
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.,
B.Disability Retirement Allowance
If a member has an injury or illness rhar prevents rhe member from performing rhe cusromary
duties of his or her regular posirion,rhe member may be eligible for a disabiliry rerirement.If
a member's disabiliry is rhe resulr of a job-relared illness or injury,and rhe member is a school,
local or Srare safery,Srare peace officer/firefighrer,Srare indusrrial,or Srare parrol member,rhe
member may be entitled ro an indusrrial disabiliry rerirement.Local miscellaneous members
also may be eligible if their employer contracrs wirh CalPERS ro provide for an industrial
disability rerirement.
A member who is gran red a disability rerirement receives rhe grearer of rhe service rerire-
menr allowance (if eligible)or an allowance based on a specified formula applicable ro rhar
member.A member who is gran red an indusrrial disability rerirement allowance receives rhe
grearer of his or her service rerirement allowance (if eligible)or a specified percentage of rhe
member's "final compensarion"(usually 50%,but 60%for some members),plus an annuity
purchased wirh his or her accumulared addirional contributions.
"California law clearly establishes that public employee
retirement benefits are a form of deferred compensation and
part of the employment contract."
C.Purchase of Service Credit
If rhey meet eligibility requirements,acrive members are entitled ro purchase addirional
retirement service credit,which increases their retirement allowance.Additionally,where
eligible,members can purchase service credit for prior public service,milirary service and
certain other types of service.The member's COSt ro purchase addirional service credit is
ser by starure and is based on acruarial assumprions and methodologies determined by rhe
Board of Administration ("Board").
D.Death and Survivor Benefits
CalPERS provides benefirs ro rhe beneficiaries of active and retired members upon rhe
member's death.Benefits and eligible recipients vary based on whether the member was still
working at the time of death or was retired,and by rhe member's employer,occupation and
rhe specific provisions in the contract between CalPERS and the employer.Additionally,a
member may Opt ro have his or her retirement allowance reduced in order ro increase the
benefits rhar will become payable ro rhe member's beneficiaries afrer rhe member's dearh.
Vested Rights of CalPER5 Members [ 5
1-50
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E.Cost of living Adjustments
A member's (or beneficiary's)iniIial allowance is subjecI to annual cosr-of-living adjusrmems
("COLAs")maI accoum for changes in Ihe applicable cosr ofliving index each year.Members
and beneficiaries also may Ieceive addiIional "Purchasing Power ProIection"when annual
COLAs have been subsramially eroded by inflation over Iime.
F.Member Contribution Rates
Members generally comribure portions of their paychecks towards the cosr of their future
retirement benefits.These member contributions are established in various ways,including
among other by sratute,ordinance and memorandum of understanding,and they vary widely
based on such things as the member's employer,occupation and bargaining unit,if any.In
general,member comriburion rates are esrablished as a percemage of the member's momhly
compensation.With respect to member comriburions esrablished by srature under the PERL:
"The Legislature reserves the righI ro increase or otherwise adjusr the raIes of [member]comri-
burion ...in amounts and in a manner it may from rime to time find appropriate."Some
member comriburion rates also are expressly subject to collective bargaining.
Some employers may choose to pay a portion or all of Ihe retiremem comriburions other-
wise required of Iheir employees.These payments typically are negotiated during collecIive
bargaining and the law provides that the employer may "periodically increase,reduce,or
eliminate"such payments.
G.Reciprocity
The "reciprocity"provisions of the PERL (and related provisions in the retitemem laws govern-
ing other California public retiremem sysrem)provide for certain reciprocal retiremem benefirs
for a person who works for twO or more public employers during his or her career,with
membership in tWO or more California public retiremem sysrems.
The primary purpose of reciprocity is ro "eliminateD Ihe adverse consequences a member
·mighr otherwise suffer when moving from one retirement system to anorher:'-Reciprocicy
provisions accomplish this in a number a ways,including,for example,allowing a member ro
use his or her highest compensation in any reciprocal system to determine the compensation
used to calculate bene firs from all such sysrems.
6 I Vested Rights of CalPERS Members
1-51
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III.Overview:Employer Funding Obligations
The California Supreme Courr long ago esrablished rhat a promise of a pension ma&by
a public employer to its employees is a promise the employer must keep.In other words,
public employers in California are legally required to honor promises to current and former
employees regardless of how much money they have set aside for that purpose.
[n order to ensure that their promises are kept,the law requires California's public
employers to pre-fund the benefits they owe by making contributions to CalPERS along
with the contributions of their employees.By investing the combined contributions of
members and employers,CalPERS is able to pay all of the benefits as they come due.
To successfully fund all promised benefits,the law requires the Board to maintain an
actuarially sound retirement fund.As one courr explained:"Actuarial soundness of [CalPERSj
is necessarily implied in the tota!contractual commitment,because a contrary conclusion
would lead to express impairment of employees'pension rights."Furrher,employees have a
vested right to statutorily required employer contributions,even where those contributions
are not linked to ptoviding an "actuarially sound"retirement system.
"...a promise of a pension made by a public employer...is a promise the
employer must keep.In other words,public employers in California are legally
required to honor promises to current and former employees ..."
The California Constitution provides that the Board "shall []have sale and exclusive
responsibility to administer the system in a manner that will assure prompt delivery of benefits
and related services [Q the participants and their beneficiaries"and "consistent with the exclu-
sive fiduciaty responsibilities vested in it,shall have the sole and exclusive power to provide
for actuarial services in order to assure the competency of the assets of the public pension or
retirement system."The Board has authority to determine an actuarially sound rate of contri-
burions that,rogerher with investment earnings.will "assure the competency of the ~ssets"
of CalPERS such that all promised benefits are paid now and in the future.It is the Board's
exclusive responsibility to determine the contributions that will be required of the parricipating
employers and the parricipating employers then have a mandatoty "ministerial"duty to pay the
contributions that the Board determines are necessary.This obligarion will be quickly enforced
by the courtS,by writ of mandate,if an employer fails to meet it.
As stated by the United States Supreme Courr,a defined benefit plan "is one where the
employee,upon retirement,is entitled to a fixed periodic payment.The asset pool [available
to pay benefits]may be funded by employer or employee contributions,or a combination
ofborh.Bur the employer typically bears the entire investment risk and ...must cover any
underfunding as the result of a shorrfall that may occur from the plan's investments."
Vested Rights of CalPERS Members I 7
1-52
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IV.California Contract Clause as Applied to Public
Employees'Retirement Benefit Rights
A "vested"benefit is one that has mamred into an irrevocable contractual righr',t which cannot
be taken away or otherwise impaired without the member's consent,except in extremely limit-
ed circumstances.A "non-vested"benefit,on the other hand,is one that has been promised
conditionally.It is generally alterable or completely revocable by the appropriate authority
(usually the LegislatUre or the employer)without the member's consent.A public employee's
right to the retirement benefits earned during employment is generally a vested right.
California has a Strong public policy,enunciated through published legal decisions over
the past half century,establishing that public employee retirement benefits are contractual
obligations entitled to the protection of the "Contract Clause"of the State ConstitUtion.
That clause,found at Article I,section 9 of the California ConstitUtion provides:"A ...law
impairing the obligation of contracts may not be passed."(Article I,section 10 of the United
Srates Constitution similarly prohibits a state from impairing the obligation of contracts.)
This means that an employee's vested pension rights may not be impaired except under
extremely limited circumstances.
The fundamental doctrine protecting California public employee pension rights is
succinctly scared:"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 entity."
This doctrine has been applied and refined by dozens of California appellate cases since
the 1940s.Several general rules have emerged through this jurisprudence:
RULE 1:
Employees Are Entitled To Benefits In Place During Their Employment
Public employees obtain a vested right to the provisions of the applicable retirement law
.that exist during the course of their public employment.Promised benefits may be increased
during employment,but not decreased,absent the employees'consent.
These rules apply to all active CalPERS members,whether or nor they have yet performed
the requirements necessary to qualifY for certain benefits that are part of the applicable retire-
ment law.For example,even if a member has nor yet satisfied the five year minimum service
prerequisite to receiving most service and disability benefits,the member's right to qualifY for
those benefits upon completion of five years of service vests as soon as the member starts work.
The courts have established that this rule prevents not only a reduction in rhe benefits that
have already been earned,bur also a reducrion in the benefitS that a member is eligible to earn
during futute service.For example,a ballot proposition that purported to eliminate futUre
benefit accruals for legislators was held unconstitUtional because legislators were entitled to
continue earning benefits under the law in place when they were first elected.
8 I Vested Rights of CalPERS Members
1-53
RULE 2:
Employees Are Entitled Only to Amounts Reasonably Expected from the Contract
Vested rights protection does not exrend to unreasonable or unanricipated windfalls.In other
words,the Contract Clause only protects the benefits that are reasonably expected from the
contract,and does not protect "unforeseen advantages."
RULE 3:
Only Lawful Contracts with Mutual Consideration Are Protected by the Contract Clause -
"The contract clause does not protect expectations that are based upon contracts that are
invalid,unenforceable,or which arise withour the giving of consideration.Nor does the
contract clause protect expectations which are based upon legal rheories other than conrract,
such as quasi-contract or estoppel."
For this reason,it is not an "impairment of contract"for CalPERS to correct an error by
a member,the member's employer or CalPERS'staff that may have resulted in more favorable
treatment to the member than the law allows.The PERL specifically authorizes CalPERS to
correct such errors.
RULE4:
Future Employees Have No Vested Rights to the Current Statutory Scheme
Employees to be hired in the future do not have vested rights to any particular retirement
benefits because they have not yet entered into public employment.Thus,there is no consti-
tutional impediment to unilaterally reducing (or even eliminating)retirement benefits for new
hires of public employers,even if the public employers historically have provided such benefits
to their employees as part of past employment conrracts.
RULES:
Retired and Inactive Members Have Vested Rights to the Benefits Promised to
Them When They Worked
Like active employees,retirees and inactive members have a vested right ro the benefits that
were in place when they were employed.However,retirees and inactive members generally
do not have vested rights to beneficial changes created after their employment terminates.
This is because a "member whose employment terminated before enactment of a statute offer-
ing additional benefits does not exchange services for the right to the benefits."An exception
to the general rule that benefits granted after retirement are not vested arises when the retiree
Vested Rights of CalPERS Members I 9
1-54
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or inactive member gives up anorher righr acquired during employment in excl\ange for the
right to receive post-employment improvements.In that case,the right to a post-employment
improvement is generally a vested right.
RULE6:
Active Employees'Vested Rights May Be Unilaterally Modified Only
Under Extremely Limited Circumstances
Active public employees have a vested right to a substantial pension,bur,under limited
circumstances,the terms of their retiremenr rights may be modified before rhey retire.The
California Supreme Coun has explained:"[V]ested contractual pension righrs may be modified
prior to retirement for the purpose of keeping a pension system flexible to permit adjustments
in accord with changing conditions and ar rhe same time maintain rhe integrity of the system.
Nonetheless,such modifications must be reasonable.and [Q be sustained as such,alterations of
employees'pension rights must bear some material relation to the theory of a pension sysrem
and its successful operation,and changes in a pension plan which result in disadvantage to
employees should be accompanied by comparable new advantages.Funher,it is advantage or
disadvantage to the panicular employees whose own contractual pension rights,already earned,
are involved which are rhe criteria by which modifications to pension plans must be measured."
There are numerous California published decisions thar discuss rhe circumstances under
which modifications to the vested rights of active employees may be permitted.There are four
primary steps for determining whether a modification is permissible:
(a)The first step in derermining whether a modification is permissible is to determine if
the unmodified right is in fact vested,meaning neither rhe employer nor the Legislature
reserved the right to change the benefit.This is because rhe applicable retiremenr laws ofren
contemplate changes.Indeed,the laws sometimes expressly reserve to the employer or the
Legislature the right to modifY or eliminate cenain benefits.A member's ve·sted right is
only to the law as it is written at the time of employment,including all of its conditions.
(bl If a vested right exists,the next step is to determine whether rhat vested right has been
changed in a way that is disadvantageous to the member.
(c)If it is determined that a vested right has been changed in a way that is disadvantageous
to a member.the next step is to determine whemer the change has a "material relation
to rhe theory of a pension sysrem and its successful operarjon."Ifit does not,then the
modification is not permissible.Case law is clear that "changes made to effect economies
and save the employer money do bear some material relation to the theory of a pension
system and its successful operation,"but,as discussed immediately below,this finding alone
is nor sufficiem co justify a disadvantageous change [Q a member's vested rights.
10 I Vested Rights of CalPERS Members
1-55
(d)If the change bears a "marerial relation to the theory of a pension system and j',s
successful operation,"the final step is to determine whether the disadvantaged employees
will receive a "comparable new advantage."When a COUrt conducts this analysis,it looks
specifically ar what may be taken from and provided to the individually impacted employ-
ees.This member-by-member analysis,however,does not necessarily take into account each
member's unique personal circumstances.Thus,a member does not get to pick and choose
which advantages or disadvantages will apply to him,and then argue that his vested rights
have been unconstitutionally impaired.
RULE 7:
The State's "Emergency"Powers Are Extremely limited and Cannot Be Used
to Reduce the Benefits that Have Been Promised
The courts have carved out one narrow exception co the constitutional prohibition against
rhe impairment of contracts,although there is no case where a COUrt has actually applied
that exception in a way that has reduced the long term COstS of public retirement benefits in
California.Both the California and United States Supreme Courts have held that "a substan-
tial impairment may be constitutional if it is "reasonable and necessary to serve an important
public interest"during an emergency.The courts pay little heed,however,to the "legislative
assessment of reasonable and necessary,"because "the State's self-interest is at stake [and aJ
governmental entity can always find a use for extra money,especially when taxes do not have to
be raised."Thus.the COuttS apply a rigorous four-prong test when determining if this limited
exception applies:(a)the legislative enactment must serve to protect "basic interests of society;"
(b)there must be an "emergency justification for the enactment,"(c)the enactment must be
"approptiate for the emergency;"and (d)the enactment must be "designed as a temporary
measure,during which time the vested contract rights are not lost but merely deferred for a
brief period,interest running during the temporary deferment."
Thus,even if vested pension rights may be temporarily impaired in a true emergency
situation,it is clear that the State's emergency powers do nor enable it to solve its budgetary
problems by eliminating or reducing rhe long rerm benefit promises ir has made.
Vested Rights of CalPERS Members I 11
1-56
'.
V.Federal Contract Clause as Applied to Public Employees'
Rights in California
As srared above,ir is clear rhar rhe "Comracr Clause"of rhe California Consrir'~rion provides
broad prorecrions of rhe vesred pension righrs of California's public employees.Some currem
"reform"proposals suggesr changing rhe Srare Consrirurion ro reduce or e1iminare public
employee retirement benefits,in some instances even amending the Cantraa Clause itself
Presumably,proponenrs of rhese measures assume rhar by amending rhe Srare Consrirurion,
rhey can avoid a consrirurional challenge ro rheir proposed impairmem of vesred reriremem
benefits.The assumption is misplaced l for [\YO reasons:
First,if a proposed pension reform were to be enacted in the form of a consricurional
amendmem,ir would srill have ro pass musrer under rhe Comract Clause of rhe Srare
Consrirurion.In orher words,any new provision of rhe Srare Consrirurion would sri II be
subjecr ro rhe requiremem rhar ir nor impair rhe obligarion of comracrs.Absem acrually
e1iminaring rhe emire Comracr Clause,rhe facr rhar a pension reform measure may be
adopred by way of a consrirurional amendmem would nor assure irs validiry.
"Some current 'reform'proposals suggest changing the State Constitution
to reduce or eliminate public employee retirement benefits ...Presumably,proponents
of these measures assume that by amending the State Constitution,they can avoid
a constitutional challenge to their proposed impairment of vested retirement benefits.
The assumption is misplaced ..."
Second,even if a proposed amendmem e1iminared rhe Srare Consrirurion's Conrran
Clause in irs emirery,the Conn'act Clause ill the United States COlIStin/tioll wOllld give rise to
the same protection ofvested pension rights as rhe Srare Consrirurion.Most of rhe published
California cases rhar have analyzed the constirurionaliry of modiJYing vesred pension righrs
of public employees have nor meaningfully disringuished berween rhe Comracr Clause in rhe
California Consrirurion and rhe Conrran Clause in rhe Unired Srares Consrirurion.In 1991,
rhe California Supreme COUf(removed any doubr rhar rhe Unired Srares Consrirurion prorecrs
pubiic employee pension righrs in California ro rhe same exrem as rhe California Consrirurion,
by explaining rhar prior case law had "never rejecred rhe federal clause as a source of prorec-
rion"and "in light of prior California decisions consisrenrIy exrending federal comracr clause
prorecrion ro srare public officers,ir is simply 'roo lare'to retrear from rhe clear implicarion of
rhose holdings."
Therefore,anlending rhe California Consrirurion likely would nor open rhe way ro lawfully
impairing vesred pension righrs.All of rhe rules discussed in Secrion IV above likely would srill
apply,no marrer how rhe California Consrirurion may be amended,so long as rhe Comracr
Clause of rhe Unired Srares Consrirurion remains unchanged.
12 I Vested Rights of CalPERS Members
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VI.CalPERS Members'Rights
Based on the legal analysis set forth above,CalPERS here articulates its undemanding of the
current state of vested rights law in California,as it applies ro CalPERS members'benefits.
Analyzing any particular member's vested rights,however,must be done on a case-by-ca.se
basis.Thus,nothing in this section is intended to express a view on any individual member's
tights or any specific legislative or constitutional proposal.Further,the discussion in this
secdon is nor intended to be exhaustive,bur rather [Q provide a general overview of our
members'primary rights.
A.Vested Rights
In general,CalPERS members have vested rights to:
»Have their service retirement allowance determined based on the benefit formula that
existed in ,he law when they provided service,if ,hey satisfy all eligibility requirements.
»Have thei,retirement allowance based upon all service credit that they acccued by
providing service or by purchasing service credit.
»Have rheir retirement allowance calculated using the definition of "final compensation"
that existed in the law when rhey provided service.
})Have their "final compensation"determined according to the definicion of "compensation
earnable"that existed in the law when they provided service.
»Receive a disability allowance or an industrial disability allowance determined in
accordance wirh rhe law rhat exiSted when they provided service,if the member satisfies
all eligibility requiremen,s.
»Purchase service credit unde,the terms that existed in the law when they provided service,
if the member satisfies all eligibility requirements.
»Receive cost of living adjustments to their retirement allowance under the terms that
existed in the law when they provided service.This includes "Purchasing Power
Prorcnioo."
»Haye their beneficiaries receive death and survivor benefits provided under the rcr.ms
that existed in the law when the member provided service.
»Receive the benefits of reciprocity that existed in the law when they provided service,
if they satislY all eligibility requirements.
»Withdraw their contributions,plus acccued interest,upon separation from employment,
when eligible for such a withdrawal.
»Have an actuarially sound retirement fund,which requires (al that the CalPERS Board
establish employer contribution rates sufficient ro maintain the actuarial soundness of
the system so thar the competency of its assets is assured,and (bl that the employers
timely pay those rates.
Vested Rights of CalPERS Members I 13
1-58
.'.
Because the above righrs of CalPERS members are vested,they may only be modified
if such modifications are "reasonable,and ro be sustained as such,a1terarions of employees'
pension righrs must bear some material relation ro the theory of a pension system and its
successful operation,and changes in a pension plan which result in disadvantage ro employees
should be accompanied by comparable new advantages."
Finally,there remains a question as ro whether vested righrs may be consensually modified
through collective bargaining withour offending rhe Contracrs Clause.
B.Non-Vested Rights
In general,CalPERS members do not have vested tighrs ro:
»Benefit improvements that are granted to them afrer they have terminated employment
(e.g.,the "ad hoc"cost of living improvements granted ro retirees based upon retirement
date),unless such benefit improvemenrs have been granted in exchange for a vested right
that the retired members gave up voluntarily.
»Windfall benefirs that arise our of circumstances that were never contemplated ro be parr
of the employment COntraCL
»Payments in excess of those aurhorized by law,or arising from an error by the member,
the member's employer or CalPERS.
»Perperuarion of the Board's discretionary actions affecting contributions and benefirs.For
example,the Board may change irs actuarial assumptions and methodologies for calculat-
ing the cost for purchasing service credit,or for determining actuarial equivalency (for a
variety of purposes).The Board has full aurhority ro change actuarial assumptions and
methodologies in the sound exercise of irs discretion,and doing so does nOt impair any
vested right,even if a change does nor appear favorable ro CalPERS members.
»Continuacion of a benefit or contribution ratc where the benefit or contribution ratc
is subject ro change under the terms of rhe applicable stature,memorandum of under-
standing or employment contract.
'»Continued employment with rheir employer or the continuation of the hist~rical
compensation practices of that employer,even if those practices impact the calculation
of members'"compensation earnable"and "final compensation."For example,an
employer may have hisrorically paid cerrain premium amounts rhat qualify as pension-
able "compensation earnable."While the member has a vested right ro have such amounts
included in "compensation earnable"when paid,the member does not have a vested right
to continue to be paid those amounts.
14 I Vested Rights of CalPERS Members
1-59
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Because the above tights are not "vested"under the Contract Clauses of the California
and United States Constirutions,there is no constirutional impedimem to the Legislature
or a member's public employer (or the Board,in the case of its own discretionary acts)from
unilaterally altering those rights.Unless and umil such alterations are made,however,members
of course have a right ro receive all benefits provided ro them under law.Furrher,arher laws
may limit the abiliry ro make such alterations.For example,although specific employment
practices may not be vested in perperuity,the terms of a collective bargaining agreemem must
be honored during the period of that agreement's applicability.
Vested Rights of CalPERS Members I 15
1-60
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VII.The Role of CalPERS in Protecting Members'Vested Rights
Under the State Constirution and the PERL.the Board (which is the 13-memBer governing
body of CalPERS)has the exclusive and plenary authoriry and fiduciary dury ro administer
CalPERS in a manner that will assure prompt delivery of benefits and related services ro the
members and beneficiaries of the system.Board members are either elected by members of
the system,appointed by State elected officials or sit ex officio.
One court explained the fiduciary duties of members of a public retirement board thusly:
U[A]trustees primary dury of loyalty is ro the beneficiaries of the trust.The trustee is under
a duty ro the beneficiary ro administer the trust solely in the interest of the beneficiary.The
trustee must not be guided by the interest of any third person.This unwavering duty of
complete loyalty ro the beneficiary of the trust must be to the exclusion of the interest of all
other parties.Under ,he rule against divided loyal,ies,a fiduciary cannot contend char al,hough
he had conflicting interests,he served his masters equally well or that his primary loyalty was
not weakened by the pull of his secondary one."
The California Constirution provides:''A retirement board's dury ro its participants and
their beneficiaries shall take precedence over any other duty."The California Supreme Court
has explained:U[P]ension plans creare a truSt relarionship between pensioner beneficiaries and
the trustees of pension funds who administer retirement benefits and the trustees must exercise
their fiduciary trust in good faith and must deal fairly with the pensioners-beneficiaries."
The Board will aCt consistently with these principles.With respect ro legislative and consti-
turional proposals that may impact its members'vested rights,the Board will exercise its best
judgment and act appropriately under all existing circumstances.In doing so,the Board will
observe certain general guidelines,including:
»CalPERS will make reasonable effons ro keep its members and beneficiaries apprised of
changes or potential changes ro the law that may impact their rights and responsibilities.
»CalPERS will ensure that funds spent in any process relating ro potential changes in
funding or benefit structures are appropriate expenditures of trust funds under Article
XVI,section 17 of the California Constitution and other applicable law.
»CalPERS'actions will be carried Out in a manner that implements the law.In the event
CalPERS questions whether changes in the PERL or other applicable law may cause an
un'constitutional impairment of its members'vested rights,CalPERS will exercise its best
judgmenr,based on all exisdng circumsrances,as [Q whether [Q initiate or parricipate in
judicial challenges ro such changes ..
16 I Vested Rights of CalPERS Members
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VIII.Conclusion
CalPERS is dedicared ro adminisrering rhe sysrem in a manner rhar will ensure rhar the
promises made ro CalPERS'members and beneficiaries will be kepr.CalPERS acknowledges
rhe budgerary challenges rhar rhe Srare and orher public agencies rhroughour California are
presenrly facing,and will play an appropriare role in rhe addressing rhese challenges.In rhis
process,ir will be virally imporranr for all inreresred parries ro heed rhe legal rules prorecring
rhe vesred righrs of CalPERS'members,which have developed over rhe course of many
decades.Wirhour due considerarion of rhese rules,well-inrenrioned proposals may nor achieve
rhe purposes for which rhey are designed;indeed,mey may lead only ro addirionallirigarion
and adminisrrarive com,which can only increase rhe long rerm cosr of delivering rhe benefirs
rhar have been promised ro CalPERS members.Ir is rhe hope of CalPERS rhar rhis paper will
provide guidance ro all parries as mey address rhese challenges.
Vested Rights of CalPERS Members I 17
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JIACalPERS
California Public Employees'
Retirement System
400 Q Street
P.O.Box 942701
Sacramento,CA 94229-2701
(916)795-3991
(916)795-3507 fax
TTY'(916)795-3240
Legal Office
.,
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