Jerry Brown's Plan for Comprehensive Pension Reform

The California governor's far-reaching proposal requires hybrid plans, equal employee cost-sharing and a constitutional amendment.
by | February 9, 2012

Regardless of one's personal politics, you've got to admire or at least respect California Gov. Jerry Brown for his recent — and tenacious — pension reform efforts. Last week he sent the state Legislature comprehensive language that put meat on the bones of his 12-point pension reform proposal which I discussed last November.

Brown sent Sacramento legislators two documents: a proposed constitutional amendment and a package of statutory provisions that enable the constitutional provisions along with other reforms that do not require or merit constitutional status. Together they form the most comprehensive package of pension reforms that any governor has yet delivered to a legislature in this modern era of pension tsunamis.

I have already discussed many of the substantive points in a prior column so I won't repeat myself here. Instead I want to focus on a few specific features of the revised package and offer some constructive suggestions.

Because the more hawkish California Pension Reform (CPR) group's ballot initiative proposal reportedly will not be circulated for signatures, the governor's proposal now looks like the most likely vehicle to achieve meaningful reform this year. Also, an Arizona court just ruled that incumbent employee contributions cannot be increased in that state, which underscores the immediate necessity of a constitutional remedy to that problem in California. So I would rather help improve that document than make gadfly criticisms of its defects. Reform will not be achieved overnight, and Brown's package is a great starting point. There is a lot in his comprehensive proposal that I like, and little that I don't. In my perfect world he'd go farther, but with a few revisions, I would become a strong endorser.

First, I would again suggest that the legislative package must also address OPEB (retiree medical) plans in a companion bill if the "single-subject rule" precludes incorporating OPEB in Brown's proposed statutory definition of a retirement system. His draft arguably includes only pension plans and does so somewhat ambiguously. So as the package now stands, it only addresses half of California's huge retirement-plan funding mess because unfunded OPEB deficits are almost as large collectively as the pension underfunding. Brown's proposals that employers and employees must share equally and contribute annually to the normal cost of the retirement plan should extend over to OPEB as well. That one added fix would do more to achieve longterm fiscal sustainability in California government than any other feasible and achievable reform suggestion for the pension plans.

For the record, I am deeply gratified to see the governor's constitutional language to require all employees — including incumbents — to pay half of their plans' normal costs, to the extent feasible under labor agreements (until they expire) and the federal constitution. Having been the first industry commentator to advocate this remedy to assure that employees have equal skin in the game, I am delighted to see this and other provisions I documented in my legislative prescriptions for the Council of State Governments 2011 Book of the States and their pension reform brief on this topic. Even if they didn't take their proposals straight from my playbook, it appears that great minds think alike.

There are two additional technical revisions that should be included in the governor's language:

(1)The governor's definition of the "normal cost" — to be shared equally by employees and employers — should be the normal cost "in conformance with generally accepted accounting principles." This would assure that plan trustees don't undermine the reforms with ridiculous investment projections, inflated discount rates and credit-card amortization schedules. In a perfect world I would apply GAAP to all contributions, but in light of today's massive unfunded liabilities that is just too much to build into a viable general constitutional requirement. Although I still prefer the "at risk" emergency remedies of the competing CPR proposal, I could live with the normal-cost GAAP requirement when coupled with the OPEB reforms.

My language would make the Governmental Accounting Standards Board (GASB)'s rules for governmental plans the operative standards because GASB is the authoritative source of GAAP for governments. Pension hawks would prefer to see the private-sector accounting standards that the CPR proposal offered. I could live with either definition, but the unions will dislike the stricter approach: it could require higher contributions and allow fewer opportunities for gamesmanship. In a prior column discussing the risk-free discount-rate debate, I explained how the stricter rule could especially make sense if other reforms addressing unfunded liabilities are legally or politically unattainable.

(2) The governor has very thoughtfully proposed a hybrid retirement plan structure for all new hires statewide as well as an option for current employees. His overall plan design looks fine to me on first review, except that it essentially establishes a CalPERS (state pension system) monopoly for the hybrid plan's defined-contribution plan that would be available to local governments and local agencies.

There is no economic or governance rationale to preclude a municipal employer from using just the CalPERS or county retirement systems' pension component of its qualifying hybrid plan, and then selecting by home rule its own defined-contribution provider to build out the other wing of the constitutional hybrid plan design. Presently CalPERS offers a 457 deferred compensation plan through a private vendor that is used by only a minority of local governments. Most others have selected their own plan administrators in a highly competitive marketplace where the CalPERS plan often competes unsuccessfully. The governor's language could easily be anti-competitive and counterproductive by making the CalPERS hybrid's DC option the presumptive choice regardless of merit.

For national perspective, the Tennessee state treasurer has crafted a hybrid plan in an optional reform package for local governments that wisely recognizes the merits of permitting local competition to the state's defined-contribution vendor. Local governments with their own established deferred compensation plans may be able to secure cost-competitive and integrated defined-contribution services from the same provider on terms superior to the state's chosen plan-administration vendor. Localities should not be required to "prove" that their selection is superior if it meets efficiency standards; that's what home rule is about.

I would offer the drafting team a technical amendment that borrows from one simple sentence in the CPR hybrid plan: "For its hybrid plan, each government employer shall competitively select a defined-contribution plan administrator that offers a range of appropriate, professionally managed investment options and minimizes operations and investment costs." If employers want their pension system to provide the DC component also, that is fine, but there should be an open field for competitive alternatives since they are already out there in the marketplace. This language would also permit employers to establish a collective defined-contribution plan that shares longevity risks. The range of hybrids available to public employers and employees would thus be far more robust under this language.

Let CalPERS keep its monopoly on pension management, but put competition to work for the employees' benefit in the defined-contribution components. I'm sure that the rival industry leaders would agree with me on this one.

Political wonks tell me that the Brown proposal faces tough uphill sledding in the labor-friendly legislature, where Democrats have assembled large majorities with heavy public employee union support. However, savvy observers also say that without this kind of real-deal pension reform, the governor cannot get the Dems' desired tax increase passed this fall. That shotgun-marriage motivation may provide the impetus for union loyalists in the Capitol to acquiesce to his centrist retirement-reform package.

Overall, I give the governor an A+ for effort and a high B+ for substance in last week's documents. They provide an excellent framework for genuine reforms, which can achieve an A grade if my three constructive suggestions are incorporated. Policymakers and pension reformers elsewhere are well advised to study Gov. Brown's thoughtful proposals.

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