December 22, 2011
Pursuant to Elections Code Section 9005, we have reviewed the
proposed constitutional initiative concerning public employee pensions
(A.G. File No. 11‑0064, Amdt. #1S).
Existing Public Employee Pensions.
California governments generally offer comprehensive pension benefits to
their employees, which are funded from public employer and public
employee contributions, as well as investment earnings generated from
those contributions. Some governments also contribute to retiree health
benefits for their former employees.
Types of Retirement Plans. In general,
California public employees are enrolled in defined benefit pension
plans, which provide them with a specified benefit—generally based on
their salary levels near the end of their career, their number of years
of service, and the type of job they had while in public employment.
This is called a defined benefit pension plan, and public employees
generally are obligated to contribute only a fixed amount—as a
percentage of their pay each month—to these plans.
Public employers and employees generally are required to contribute
the amount estimated by actuaries as the “normal cost” for plans each
year. Normal costs are the amounts estimated to be necessary—combined
with future investment returns—to pay for benefits earned by employees
in that year. To the extent that the plans do not have enough money over
time to pay for benefits, an unfunded liability can result—due, for
example, to lower-than-expected investment returns or decisions to give
retroactive benefit increases that apply to prior years of service. In
general, public employers bear all of the responsibility to pay for such
unfunded liabilities. As of 2008‑09, the most recent year for which data
are available from the State Controller’s Office, public employers paid
a total of about $14 billion to pension systems to cover benefit costs,
including several billion dollars to pay for unfunded liability costs.
Many California governments also provide their employees with options
to contribute funds to defined contribution retirement plans, which are
common in the private sector. Defined contribution plans do not promise
a defined benefit like those described above. Instead, these plans are
able to provide retirees with income generated from prior contributions
plus available investment returns. Employers have no obligation to
provide additional money to employees’ defined contribution accounts to
offset lower-than-expected investment returns.
In addition to defined benefit and defined contribution plans, many
California public employees also are eligible to receive Social Security
benefits. Teachers and many public safety workers, however, generally
are not eligible for such Social Security benefits.
Contract Clause. Courts have ruled that
public employees in California accrue certain rights to pension benefits
on the day that they are hired and, over time, they typically accumulate
more pension benefit rights. Contracts related to pensions sometimes are
included in collective bargaining agreements or in statutes, but in some
cases, they may be “implicit” (or unwritten) commitments based on their
employer’s past practices. Both the U.S. and California Constitutions
contain a clause—known as the Contract Clause—that prohibit the state or
its voters from impairing contractual obligations. Interpreting these
Contract Clauses, California courts have ruled for many decades that
pension benefits for current and past public employees can be reduced
only in rare cases—generally, when public employers provide a benefit
that is comparable and offsets the pension contract that is being
impaired or when employers previously have reserved the right to modify
This measure amends the California Constitution to impose new
requirements and limitations concerning public employee retirement
benefits and the funding of those benefits by public employers and
employees. The measure establishes different retirement benefit
requirements for public employees hired before July 1, 2013 (referred to
below as “current public employees” or “current employees”) and public
employees hired on or after July 1, 2013 (referred to below as “future
public employees” or “future employees”). Assuming the measure is
adopted by voters in November 2012, current employees, therefore, would
include public employees hired between the date this measure is adopted
and June 30, 2013.
Pensions for Employees Hired On or After July 1, 2013
This section describes this measure’s limitations on retirement
benefits and the funding of such benefits for future public employees.
“Hybrid Plan” to Be Established. For future
public employees, the measure requires the Legislature, by a two-thirds
vote, to establish a hybrid retirement plan. (In retirement policies,
hybrid plans are considered plans that combine elements of defined
contribution and defined benefit pension plans.) The hybrid plan would
be designed so that a future employee’s retirement benefit would consist
of up to three components: defined contribution, defined benefit, and
federal Social Security benefits (if the employee is eligible). In
aggregate, these benefits would be designed to replace up to 75 percent
of an employee’s base wage (defined as an employee’s average highest
three years pay). It is unclear if the measure would result in each
component representing an equal share of the 75 percent.
The full benefit of the hybrid plan (75 percent replacement income)
would only be available to employees after attaining a specified age and
working a full career, as defined by the measure. Figure 1 shows the
career and age requirements necessary for safety and non-safety
employees to earn the full benefit. The measure specifies that an
employee can retire up to five years before he or she reaches the full
retirement age, but in this instance, the defined benefit portion of the
employee’s retirement benefit would be lower than if he or she retired
at the full retirement age.
Limitations on Defined Benefit Component of the Hybrid
Plan. The measure places specific limitations on the
defined benefit that would be available to future public employees. The
formula used to determine an employee’s pension would use his or her
average highest three years’ base wage as a public employee. The measure
would limit the size of a future employee’s defined benefit pension so
that it could not exceed (1) $100,000 (annually adjusted for inflation
beginning in July 2014), and (2) 25 percent (for employees who
participate in federal Social Security) or 50 percent (for employees who
do not participate in Social Security) of base wage after a full career
in government service. Under the measure, future employees and public
employers would share equally all costs associated with the defined
benefit, including any payments for unfunded liabilities. The measure
adds a requirement to the California Constitution that requires public
pension plans to adopt accounting and actuarial standards that minimize
unfunded liabilities related to future employees.
Defined Contribution Component of the Hybrid Plan.
Under this measure, public employers each would select a defined
contribution plan administrator. Upon retirement, a future employee
would have the option to use the money in his or her defined
contribution account to purchase an annuity underwritten by regulated
financial institutions meeting capital and financial standards
established by the Legislature. A government employer or retirement plan
may offer a collective defined contribution plan so long as the public
employer or taxpayers bear no risk for additional contributions. The
measure does not indicate whether, or to what extent, employers match
employee contributions to a defined contribution plan.
Pensions for Employees Hired Before July 1, 2013
This section describes this measure’s limitations of retirement
benefits and the funding of such benefits for current public employees.
Pension Modifications for Current Employees Retiring
After June 2016. Under this measure, a current employee
who retires after June 30, 2016 would be able to receive pension
benefits based only on the average of his or her highest three years’
average annual base wage.
Annual Review of Plans’ Funded Status. This
measure requires the administrator of each defined benefit retirement
plan for current employees to obtain an independent review of the plan’s
assets and liabilities and determine the plan’s funding status each
year. This independent review would have to follow potentially stricter
standards than those currently used by California’s defined benefit
public pension systems—specifically, the accounting standards and
assumptions established by federal law for private-sector pension plans,
including those established by the federal Employee Retirement Income
Security Act (ERISA). If the independent review determines that a plan’s
assets cover less than 80 percent of its liabilities, based on the
standards included in the measure, the plan would be considered “at
risk.” Once a plan is considered at risk, the public employer would be
required to either (1) appropriate the funds necessary to fund the plan
above the at-risk level or (2) find and declare that making the
appropriation necessary to fund the plan above the at-risk level would
impair the public entity’s ability to provide essential governmental
services. If a public employer makes the latter declaration, the measure
(1) requires employees to contribute more to the plan until the plan’s
funding exceeds the at-risk level, and (2) gives the affected employees
the right to withdraw from further participation in the at-risk plan and
enter into the retirement plan available to future employees. Moreover,
current employee and public employer contributions would change as
described below so long as pension plans are deemed at risk.
Contributions to Pay for Normal Costs of At-Risk Pension
Funds. Under this measure, if a public employer declares
that it cannot fund an at-risk plan for current employees without
impairing essential services, the public employer would be required to
limit its contributions to the normal cost to 6 percent of a non-safety
employee’s pay and 9 percent of a safety employee’s pay. For employees
who do not participate in Social Security, public employers would also
contribute an additional amount equal to 25 percent of the cost of the
defined benefit component of future employees’ hybrid plan. The balance
of the normal cost generally would be contributed by current employees,
provided, however, that current employees’ share of pension costs could
not increase by more than 3 percent of pay per year. (If this 3 percent
of pay limit, however, otherwise would result in normal costs not being
fully funded in any year, the public employer would be required to make
additional contributions above the limits described earlier to ensure
that normal costs are fully funded each year.)
Contributions to Pay for Unfunded Liability Costs of
At-Risk Pension Funds. If a public employer’s contribution
to the normal cost of an at-risk plan under this measure is less than it
contributed before the plan was considered at risk, the employer would
contribute the difference to the unfunded liability of the fund. The
measure states that public employers would be able to require employees
to make additional contributions to the unfunded liability determined to
be “necessary and equitable,” but the employee’s aggregate contribution
to normal costs and unfunded liabilities never could increase by more
than 3 percent of pay each year. There is no limit to the total amount
of pay current employees contribute to plans as long as their
contributions do not increase by more than 3 percent of pay each year.
The measure makes a number of other changes to the retirement
benefits received by public employees and the systems that provide those
Death and Disability Benefit Administration Changes.
Public employers that provide retirement benefits for their employees
may also “separately provide” death and disability benefits to their
employees, regardless of the employee’s date of hire. The cost of such
death and disability benefits is not subject to the cost limitations
established by the measure. Death and disability benefits for employees
hired on or after July 1, 2013 would have to be provided separately from
the system that administers their pension, defined contribution, or
similar retirement benefits, except for integrated defined contribution
benefits (an undefined term).
Retroactive Benefits Prohibited. Under this
measure, public employers no longer would be able to provide increases
in pension plan benefits or formulae applicable to prior years of
service—otherwise known as “retroactive increases” in employees’ pension
Limits on Cost-of-Living Increases for All Current and
Future Retirees. For all current and future state and
local retirees, this measure states that it would amend existing pension
benefit contracts to limit annual percentage cost-of-living increases
after December 31, 2012, to no more than the annual Social Security
Pensions for Certain Felons Prohibited.
This measure provides that a public employee convicted of a felony
arising out of his or her service to a government agency cannot receive
public pension benefits for his or her service to “such government
agency.” (It is not entirely clear whether this would prohibit the felon
from receiving pension benefits related to their service for another
government agency, for which there was no related felony conviction.)
“Air Time” Purchases Generally Prohibited.
This measure prohibits government employees from purchasing additional
retirement service credit—often called air time—for any period that does
not qualify as government service or military service.
Pension Contribution Holidays Generally Prohibited.
Both public employers and employees would be required to contribute to
the normal cost of defined benefit pension plans each year unless the
plan is more than 120 percent funded under the various private-sector,
ERISA, and other funding standards described in this measure for
evaluating the at-risk status of current employees’ pension plans.
Alterations to Future Pension Benefit Accruals.
This measure requires public employers to reserve the right to make
prospective changes to pension, defined contribution, and similar
retirement benefits at their sole discretion. (It appears that this
change would apply to current—as well as future—employees under this
Changes to Composition of Public Retirement Boards.
This measure amends existing constitutional provisions related to the
composition of California’s public retirement system boards. Under this
measure, beginning on July 1, 2013, at least a majority of the members
of the governing board of every public retirement system would be
required to (1) have demonstrated expertise in a specified area and (2)
not be members or beneficiaries of any California government pension
plan or retirement system or have immediate family members who are
members or beneficiaries of such a plan or system. In addition, the
state’s Director of Finance—an official appointed by the Governor with
the advice and consent of the State Senate—would serve as a voting
member of any state or local pension system with total liabilities that
exceed $5 billion. (Because this $5 billion figure is not adjusted for
inflation, over time, the Director of Finance probably would join each
public pension board in the state.)
Judges Excluded From the Pension Limits.
This measure applies its various pension plan changes to current and
future public employees, which the measure specifically defines to
exclude California’s judges. Accordingly, the judges’ retirements
plans—administered by California Public Employees’ Retirement
System—would be unaffected by this measure.
State Contract Clause Would Not Apply. The
measure contains provisions that override existing sections of the
California Constitution and other laws to the extent that they are in
conflict with this measure’s requirements. For example, changes to
current employee and related public employer pension contributions are
required to be put in place notwithstanding provisions of existing
contracts or the California Constitution’s Contract Clause.
This measure would make changes to hundreds of different public
employee pension plans throughout the state. It would almost certainly
be subject to a wide array of serious legal challenges pertaining to its
changes to benefit plans that enroll current and retired public
employees, including, but not limited to, suits alleging that the
measure would impair public contract obligations under the U.S. and/or
California Constitutions. Moreover, the provisions of this measure would
be subject to potentially varying interpretations by public employers
and pension systems. In some cases, provisions of the federal Internal
Revenue Code—which governs the tax status of public pension plans—may
limit the flexibility of pension systems to implement certain provisions
of this measure. Given all of these factors, there is large uncertainty
about this measure’s possible fiscal effects, which we attempt to
describe below. There is also large uncertainty about how this
measure—applying broadly to nearly every type of government worker—would
apply to the variety of public employees in California, which include
teachers, public safety workers, office workers, professors, and many
Impacts Related to Future Employees
Potentially Large Retirement Benefit Savings Over the
Long Term. Under the U.S. and California Constitutions,
public employers generally are free to alter existing contractual
obligations, such as those for pension benefits, as applied to employees
hired after the date of that alteration. The fiscal effects of these
provisions on state and local governments would depend on the design of
the hybrid retirement plan adopted by the Legislature. Depending on this
program design, California public employers potentially would be able to
reduce their retirement benefit costs by billions of dollars per year
(in current dollars) once public employees hired on or after July 1,
2013 constitute the bulk of their workforces. This likely would not
occur until several decades from now.
Included in such cost savings are likely reductions in public
employers’ costs to provide health benefits to retired future employees.
While not affected specifically by this measure, these retiree health
benefits generally would cost less for governments over the long term
because future employees would likely retire at later ages than current
employees. Thus, governments would pay for these benefits for fewer
years, and under current federal law, the Medicare program of the U.S.
government would pay a greater share of these benefits for future
Offsetting Increases in Other Compensation Costs.
To ensure that total compensation for future employees is
competitive with that offered by other employers, many public employers
likely would increase pay, health benefits, or other non-retirement
benefits for future employees. This would partially offset the
retirement cost savings described above.
Impacts Related to Current Employees
It is unclear how exactly this measure’s at-risk funding status
evaluations would have to be conducted. We assume for purposes of this
analysis that most—perhaps all—California public pension plans (which
have significant unfunded liabilities under existing accounting methods)
would initially be at risk under the definitions of this measure.
Furthermore, we assume few public entities would be able to appropriate
enough money to immediately change their plans’ status. As noted above,
this could result in substantial changes to employer and current
employee contributions to pension plans so long as the at-risk status
Possible Decrease in Pension System Investment Returns.
Under this measure, future employees’ hybrid plans would
contain defined benefit pension components that are considerably smaller
than those offered to current employees. Total contributions to pension
systems for future employees’ defined benefits, therefore, will be much
smaller than the total current contributions related to current and past
employees. Defined benefit pension plans would experience a reduction in
their incoming cash flow that would become more substantial over the
coming few decades, as future employees grow to a larger share of the
public workforce. These reductions in cash flow could cause many
California pension plans to shift their allocation of investments to
ensure they can meet existing benefit obligations, thereby reducing
their average annual future investment returns. In general, when pension
plans have to assume lower investment returns in this manner, their
estimated normal costs increase, as do estimates of their unfunded
liabilities. For these reasons, in the short and medium term (perhaps
over the next two or three decades), these changes could result in
public employers having to contribute over $1 billion more per year (in
current dollars) to cover pension costs of current and past employees.
Effects of Shift of Costs to Current Employees.
This measure contains provisions that seek to shift pension
costs from public employers to current employees over time. For example,
the measure contains limits on employer contributions for normal costs
related to current employees and allows shifts of unfunded liability
costs to employees in some cases. If able to be implemented fully, these
provisions could help reduce some public employers’ annual pension costs
during some periods in the coming few decades. By shifting costs to
current employees in this manner, some public employers could encourage
or induce employees to “opt out” of existing pension plans and shift to
the plans authorized for future employees under this measure.
Other Potential Public Employer Savings.
For some current employees, this measure would provide for lower pension
benefit costs by requiring benefits to be based on the highest three
years’ average base pay—rather than existing benefit provisions (often
based on the highest single year’s pay). The measure also would limit
future cost-of-living increases for all current and future retirees. If
able to be implemented, these changes could reduce public employers’
costs for current employee benefits during the next few decades. The
amount of this savings is unknown, but likely of a lower magnitude than
the other savings and cost issues described above.
Potential Public Employer Costs. As with
their costs to compensate future employees, public employers likely
would increase pay, health benefits, or other non-retirement benefits
for current employees to ensure their competitiveness in the labor
It is unclear exactly how the measure’s provisions for death and
disability benefits would affect current employees and their
beneficiaries. To the extent that the measure requires these benefits to
be provided outside of existing retirement systems and governments
provide death and disability benefits similar to those now in place,
increased costs could result for some public employers.
In the short and medium term (perhaps the next two or three decades),
the various financial effects of this measure make its net fiscal
effects for state and local employers difficult to determine. During
these decades, public employers may face either increased costs or
savings related principally to current and past employees’ pension and
other retirement benefits.
Over time, a greater portion of public employers’ personnel costs
would be related to future employees—those hired on or after July 1,
2013, and, therefore, subject to the hybrid plan requirements to be
adopted by the Legislature under this measure. For these future
employees, depending on this hybrid plan’s design, governments may
experience substantial savings in retirement costs. These savings would
be partially offset by higher costs for employee salaries and
non-retirement benefits in order to keep public-sector compensation
levels competitive in the labor market. Accordingly, when costs for
these future employees constitute the bulk of public employers’
personnel costs—several decades from now—governments could experience
significant net savings.
Summary of Fiscal Effects
This measure would result in the following major fiscal effects for
state and local governments:
- Over the next two or three decades, either increased annual
costs or annual savings in state and local government personnel
costs, depending on how this measure is interpreted and
- In the long run (several decades from now), depending on how the
Legislature designs the required hybrid retirement plan, potential
annual savings in state and local government personnel costs of
billions of dollars per year (in current dollars), offset to some
extent by increases in other employee compensation costs.
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