Summary of LAO Findings and Recommendations on the 2011-12 Budget

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Budget Issue
LAO Finding Or

Last Updated
 Go Back  Proposal for $1.5 million to study hybrid pension systems Unclear value of Governor's hybrid plan study proposal. Inappropriate for CalPERS to lead effort. Recommend that if the Legislature appropriates $1.5 million from the General Fund, as proposed by the Governor, to "study and identify alternatives for hybrid pension systems" for public employees, that it reject the Governor's plan to have CalPERS be the entity that conducts this study. Given CalPERS' independent fiduciary and rate setting roles under our Constitution, placing it in this role of advising the Governor as he develops a pension policy proposal would be inappropriate. 5-20-11

Detailed Narrative


What Is a "Hybrid Plan?" Hybrid retirement plans typically consist of a smaller "defined benefit" pension plan than those currently prevalent among California public employees as well as a "defined contribution" plan that may or may not involve employer contributions. In defined contribution plans, unlike defined benefit plans, employers generally cannot incur any unfunded pension liabilities for prior years' employee service. Accordingly, over the long run, hybrid plans may tend to reduce annual public employer costs to the extent that they prevent costs related to unfunded pension liabilities that otherwise would accumulate under a more expansive defined benefit pension plan. Hybrid plans and other efforts to limit defined benefit pensions also can result in offsetting increases in compensation and related costs for some employees.


Governor's May Revision Proposal. On March 31, 2011, the Governor released a statement which referred to a proposal of his that was "under development" concerning a hybrid retirement plan.  In the May Revision, the Governor makes a new proposal that the Legislature appropriate $1,500,000 from the General Fund (on a one-time basis) to pay for the California Public Employees' Retirement System (CalPERS) to "study and identify alternatives for hybrid pension systems for consideration" for "all public employee pension systems in the State of California." The May Revision proposal states that the $1.5 million of suggested funding would pay for "pension related consultation, technical advice, and fiscal analysis" from CalPERS and that the specific requests related to this funding would be coordinated by the Director of Finance. CalPERS would be able to enter into contracts with firms and individuals to complete the work funded by the Governor's proposal without meeting any other requirements for such contracts in the Public Contract Code or the Government Code, and the Department of General Services would not be required to review or approve any such CalPERS contracts. A copy of "any final document or report" funded by this section "will be provided to both the Director of...Finance and the Legislature."

LAO Comments

Unclear Value. We have no idea what the Governor is contemplating in his hybrid proposal or whether the study to be funded from this money would have any value at all. This proposal is uncommonly amorphous and inscrutable compared to the typical state budget proposal. That being said, we appreciate that efforts for comprehensive pension system modifications--now under consideration by the Governor and the Legislature--will require significant staff support time and expertise from government policy experts, lawyers, actuaries, labor negotiators, and others.

CalPERS An Inappropriate Choice to Conduct This Study. Notwithstanding our doubts about the study's value, should the Legislature choose to fund all or part of the Governor's request, we strongly urge it to prevent the administration from using CalPERS to lead the study effort. This is not meant as a condemnation of the considerable skills and abilities of CalPERS staff. Instead, our recommendation is intended to preserve CalPERS' hard-won and important independence under Article XVI, Section 17, of the California Constitution.

In June 1991, the Legislature, with the approval of Governor Wilson, enacted Chapter 83, Statutes of 1991 (AB 702, Frizzelle), which placed control of CalPERS' actuarial and rate-setting functions effectively in the hands of a gubernatorially-appointed actuary. AB 702 included a $727 million allocation--dubbed by many as a "raid" on CalPERS funds--to offset state pension contribution costs. Largely in response to AB 702, the California State Employees Association and other labor and retiree groups mobilized to place before California voters Proposition 162, a measure that essentially overturned AB 702 and amended Article XVI, Section 17, among other things, to provide that public pension systems like CalPERS, "consistent with the exclusive fiduciary 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." Proposition 162 also specified that a public pension system like CalPERS must ensure that its duties to members and beneficiaries "take precedence over any other duty," including minimizing public employer expenses (emphasis added).

The purpose of Proposition 162 was to prevent legislative "raids" on public pension funds like CalPERS, and it did this by ensuring public pension systems' actuarial independence from elected executive and legislative officials, as well as specifying that California's public pension systems must act in the interest of their members and preserving and funding their benefits, above all other possible interests. There is ample justification for trust fund fiduciaries like those at CalPERS to act in this manner. Their job is to ensure that the system is able to secure enough governmental funds and invest them in a manner that allows them to provide required benefits to current and past public employees. They are entrusted with this job, and when push comes to shove, must make every possible effort allowable under the law to prioritize the interests of public employees and retirees. CalPERS must think, act, and operate independently of the state's elected executive and legislative leaders.

The clear directives of Proposition 162 would place CalPERS in an inappropriate position if the Legislature were to agree to the Governor's proposal. The Governor openly is developing a hybrid pension proposal. Under this proposal, CalPERS would take the lead role in conducting studies that, one assumes, would have a significant impact in shaping the Governor's proposal. (Otherwise, why would the Governor propose $1.5 million of funding for this study?) In our view, this role would lead to the significant possibility that CalPERS' cherished and required independence would be severely jeopardized.

CalPERS must retain all ability--real and perceived--to adjust future pension contribution rates as it deems necessary in response to whatever pension plan is adopted by the Governor, Legislature, and voters. CalPERS must retain all ability--real and perceived--to challenge in the courts any provisions of a future pension modification that it believes illegally infringe on the contract rights of its current members and beneficiaries. CalPERS, above all, cannot, by constitutional directive, meet the requirement specified in the Governor's proposal to participate in developing a plan that "meet[s] the needs of both the employer and the employees" because CalPERS is required to place the interests of public employees first. And understandably so, in its role as an independent fiduciary and rate setter.

CalPERS' Interests Not Necessarily the Same As Other Pension Systems. CalPERS is California's largest public pension system, but there are dozens of others too: for teachers, for University of California employees, county and city systems for other public employees, and others. The interests of these systems clearly are not always the same. In some respects (but not all), some of these systems can be viewed as competitors to enroll public employees and serve public employers in some lines of business. Yet, the Governor's proposal seems to propose that CalPERS--and CalPERS alone among public systems--play the crucial role in providing advice and consultation to the administration in development of its proposal. We believe this may be viewed as an inappropriate tilting of the playing field in CalPERS' favor, compared to other public retirement systems.

CalPERS Already Required to Analyze All Bills Affecting Its Pension Funds... Chapter 1502, Statutes of 1984 (AB 2874, Papan)--Section 20236, among others, in the Government Code-- already requires the CalPERS staff and board to "provide the Legislature with an analysis of the asset and liability implications of each bill that would affect the investment strategy of this system, the funding of this system, or the benefit structure of the system." Moreover, "neither fiscal committee of the Legislature shall hear any such bill until the analysis has been provided to the committee." Under this provision, it would appear that the Legislature already has a means to know what any proposed hybrid plan would, in CalPERS' estimation, do to its systems' benefits and costs. (While there have been several efforts in recent years to reduce departments' required reporting burdens, we could locate no current section of code that relieved CalPERS of its requirements under this section.)

...And Already Has Some Funding to Analyze Each Such Bill. Section 20236 even has a funding source to allow CalPERS to complete such analyses. Specifically, it continuously appropriates up to $50,000 per fiscal year--from the Public Employees' Retirement Fund--to CalPERS for such efforts. We are confident that this funding would be sufficient to help CalPERS complete independent analyses of how any future gubernatorial proposals would affect the system, and CalPERS likely could figure out a way to direct additional existing staff resources to the analysis of such an important piece of pension legislation.

CalPERS Seems to Be Opposed to 401(k)s, a Key Part of Hybrid Plans. Lastly, in its role promoting the interests of its members, CalPERS seemingly has been skeptical of defined contribution plans, which are, naturally, a key element of any hybrid plan. In a May 19, 2011, Wall Street Journal article, CalPERS officials were said to "now see the fund playing a leadership role in the national debate over whether to overhaul public pensions and replace them with 401(k)-style plans popular in the private sector, a change CalPERS opposes." Some might debate whether or not that is an appropriate role for CalPERS to be playing. Nevertheless, this gives rise to a perception--and perhaps the reality--that CalPERS is opposed or resistant to the very idea of hybrid plans that include 401(k)-style plans as a major element. Given this perception, it seems odd that the state would spend $1.5 million to fund a CalPERS study on that very topic.

LAO Recommendation and Conclusions

Administration Has A Lot of Resources Already to Develop Hybrid Plan. Public pensions clearly are very controversial right now. The choices involved in developing a hybrid plan, however--while immensely controversial--are not fundamentally that complicated.  First, one developing a hybrid plan must decide if the overall employee and employer contributions to a hybrid plan will be less than, the same as, or more than "normal cost" contributions--annual contributions to cover the cost of pension benefits accrued each year--to existing pension plans. Second, one must decide what portion of those combined contributions will come from employees and employers, respectively. Third, one must decide what portion of the benefits will be "defined benefit" and which will be "defined contribution," thereby deciding what degree of financial risk will be placed on the public employee in future years during retirement and what elements of risk will continue to be borne by the employer.

Within the administration there are already legal experts, labor experts, and financial experts who work on both pensions (through, for example, the administration's budgeting and negotiations concerning pension plans) and defined contribution plans (through, for example, the administration's management of the state's large Savings Plus Program, a defined contribution employee savings plan). The Legislative Counsel Bureau would be charged with drafting legislation proposed by the Governor for such a plan. Accordingly, we are skeptical of the idea that the administration somehow needs a lot of extra resources to accomplish its goal of developing a hybrid proposal.

There may be a need for actuarial advice to develop good cost estimates for such plans, but as noted above, any funding for such advice probably should be granted only if the actuaries are independent of CalPERS or, for that matter, any other California public pension system. 

Recommend Rejecting Request. In the final analysis, we would recommend that the Legislature reject this request for funding. Alternatively, if it wishes to provide the administration with some such funding, perhaps the amount could be lowered. In any event, actuaries, legal experts, and other policy experts independent of CalPERS and other California public pension systems should be utilized in this study.