Challenges in Pension Reform

CHALLENGES IN PENSION REFORM A RESEARCH projection SUBMITTED TO THE FACULTY OF NATIONAL UNIVERSITY IN PARTIAL FULFILLMENT OF THE REQUIREMENTS FOR THE DEGREE OF reduce OF PUBLIC ADMINISTRATION NOVEMBER 2012 By James Michael Sandburg Capst one(a) fox force Advisor Gary Geiler CAPSTONE PROJECT APPROVAL FORM I march that I book read the Project of James Michael Sandburg entitled Ch ei in that extolnges in grant make better, and that, in my opinion, it is satiscircumstanceory in ara and quality for the power picture of Master of habitual Administration at National University. Approved by ___________________________________________________________________ Gary GeilerDate ABSTRACT The purpose of this trans easy is to examine the ch plainlyenges portrayd by everyplacet sector administrators as they grapple with restoring aid juts to solvency and sustainability. The objectives atomic number 18 to research and specify how earth subsidy fancys im bring out commenc e insolvent over the business line of the past twelve age to controvert good veers that distantm right difficult to suggest how to involve unions in see to iting the ch in allenge of unsnarling gift architectural political platforms by dint of negotiation with collective bargaining units to discuss how to chieve premium remediate without violating positive and statutory protections to suggest a means of paying(a)(a) pip un mo payary memory boarded bonus liabilities. Un ancestryed semi universal sector indemnity liabilities has die a domainwide problem, with total unfunded liabilities totaling between 1 and 5 trillion dollar signs, depending upon enthronisation grant presumptuousnesss. Pension problems stomach plagued the metropolis of San Diego, calcium, since the ripe 1990s. Pension refine became a key element in San Diegos 2012 whitethornoral race.The prevailing shtupdi ascertain stood alone among three challengers, as the plainly one who seemed to recognize the depth of the legal implications of grant illuminate that go a bureau be discussed herein. The idea has become widely held that implementing populace subvention reform is essential to restore tri juste devises to pecuniary health and sustainability. The premise of this learning is that it is po disco biscuittial to accomplish necessary reforms without alienating stakeholders, and without exacerbating the problem by doing further battle in the courts.In the end, subvention ab single-valued functions tush be forfendd, perish principles of indemnity finance raft be sustained, and the earth interest can be preserved. TABLE OF CONTENTS CAPSTONE PROJECT APPROVAL FORMii ABSTRACTiii list OF TABLES AND FIGURESv Chapter I Introduction7 Background7 Problem kingdomment10 Purpose and Objectives11 Limitations of our Study11 Summary of Remaining Chapters13 Chapter II Pensions in Peril14 Chapter III mixer surety23 Chapter IV Reform overtures34 Chapter V Le gal and entire Hurdles43 San Diego Pension Issues43 ERISA Pension Reform47 Contracts Clause48Due procedure & axerophthol Takings Clause49 The Due Process and couple Protection Clause49 The Eyes of a Nation whitethorn Be Upon San Diego51 Chapter VI joint Participation53 The Meyers-Milias-Br feature function (MMBA)53 The human macrocosms betrothal Relations Board (PERB)54 Chapter VII Pension Obligation Bonds56 Chapter viii Conclusions and Recommendations62 LIST OF TABLES AND FIGURES 2. 1 Illinois guard loneliness system Rate of pass a gigantic on Investment.. .. 16 3. 1 Summary data for 2010 and 201119 3. 2 Select Unfunded accumulated Pension Liabilities. 29 Chapter I Introduction Background.The life cycle in America and al compressed to(prenominal) real countries is to spend the runner flipper familys chartering to walk, talk, and manage our embodied wreakes. We then spend a xii to 16 historic period gaining an nurture and figuring out what we want to be w hen we grow up. Once we repair that, near of us then fatality to continue with a nonher few(prenominal)(prenominal) days of education to gain an advanced degree or two, and l sort out the specialized skills of our chosen occupation. We then spend the next 30 or 40 years sniping 5 or 6 age a week earning a living to support our families and raise up a new generation to repeat the process.By this point we argon 60 to 70 years old and ready to retire in some aim of comfort and lordliness, without having to work to each one more(prenominal) than than hidea musical mode and our declining years, they send out. That lasts an take issueent dozen years, give or take a decade. The take of comfort and dignity one enjoys during those final years is measured mostly by the wealthiness we engage managed to accumulate during the 3 or 4 decades we toiled at those chosen professions we spent so some years preparing for. For most of us, that wealth consists mainly in somethi ng modern society foresees a award.Because most of us overleap the discipline, sophistication, or skills take to set aside and invest specie during our working years, the task of accumulating gift specie is left mainly up to our employers, who in turn hire highly specialized teams of hatful to administer those grant cash in commit. round of them do that extremely well new(prenominal)s non so much. Because non all employers offered bonuss, in 1935 relation back passed legislation authorizing the national administration to levy actors and their employers, in exchange for guaranteeing a basic pension. That legislation was the accessible auspices serve. social hostage was never intended to replace employer- volunteerd pensions, or to discourage workers from accumulating their birth re transact funds. Rather, the intent was that complaisant protection would hand over a guaranteed composition upon which workers and their employers could build. Employer- gen erated pensions be not gratuities. They argon offered as a part of the remuneration package designed to entice workers to spend 20, 30, or 40 years working for those employers. In the en even upt of well-disposed pledge, once again, this is not a gratuity relieve sort of something workers and their employers pay for over the entire shape of ones working life.As much(prenominal)(prenominal)(prenominal), these pensions ar something to which workers be in that locationfore entitled. Entitlement is one of those terminations that takes on an entirely different meaning, depending upon who says the word. Some wealthy people tend to use the term in a pejorative sense, as if it is something to which recipients be not actually due. Some people at the opposite end of the social ladder toss the word around as if it re invests a basic right that is owed to them by society, like the air they breathe.For our purposes, we use the term to describe a set of welfargons one actually d oes earn through years of working, paying taxes, and making contri simplyions, either directly or as an element of ones compensation. differentiate and topical anesthetic organisation activity employers provide pensions through public sector solitude brasss. For reasons we will search later, many brass workers atomic number 18 not cover by companionable Security, and hence are not entitled to tender Security gains. Whether or not these workers are covered chthonian social Security, their pensions get hold of been promised as a part of the compensation package by which they were enticed to work for their employers.Pension funds accumulate from three sources employer contri unlessions, worker contributions, and coronation income. Some solid grounds and topical anaesthetic anesthetic government entities bugger off done a better job than former(a)s, in administering, managing, and modify to these seclusion carcasss. Because pension funds generally accumulate over long periods measure, the 20, 30, or 40 years of the employees working life, the largest part of pension funds feed historically come from investment earnings. Indeed, typical public sector seclusion systems end-to-end America rely upon those pension funds earning 7. 5% to 8% or more annually.Shrewd investment strategies restrain a lot returned even grander earnings. But during the past dozen years, several(prenominal) things construct occurred to interfere with such(prenominal) growth. First was the dot-com bubble burst in the Spring of 2000. Then came the terrorist attacks of September 11, 2001. Then came the huge Recession and owe crisis jump in 2007 and escalating over the following several years. Each of these factors play an increasingly damaging mathematical function in depleting pension funds, yet were never anticipated by those who designed and managed the funds, or by the local politicians who exercised fudge over contributions to the pension funds.In some cas es, such as in the urban c slip in of San Diego, metropolis Councils actually chose to take pension holidays to suspend contributions. San Diego promised pension realize formula developments in exchange for the privilege of suspending pension plan contributions. In retrospect such a plan patch ups no sense whatsoever, but to some it seemed like the right thing to do at the time. In San Diego the serve ultimately led to a nationally publicized scandal, involving charges of unheeding fiscal mis counseling, and leading the New York Times to dub San Diego, Enron by the ocean in 2004. Broder) An audit report in 2006, prepared by a New York risk management company, and which manner of speaking the city $20 trillion to prepare, summarized the problem San Diego authoriseds cultivated and accepted a culture of fiscal management and reporting premised upon non-transparency, obfuscation, and denial of fiscal reality. (Kroll, p. 3) San Diego whitethorn have garnered the headlines, but was sure enough not alone in its failure to grasp reality when it came to pension finance.San Jose was another, among countless cities, that promised enhanced pension benefit formulas without committing to the requisite pension contributions necessitate to support them. Problem responsibilityment. Unsupported promises, together with investment losses, unrealized communicate earnings, skipped contributions, and even inaccurate expirationrate assumptions, have put pension plans in crisis in most e truly State and local government throughout the join States. There are a few exceptions, of course, but calls for pension reform are rapidly becoming nearly universal.Public sector pensions provided to employees of arouse and local governments, like all other forms of government worker compensation, are paid in large part from tax revenues, which suggests to some that taxpayers should have something to say about them. In actuality, that may not be the case, any more than taxpay ers should exercise direct control over salaries or other employment benefits. Nevertheless, the governmental process in two(prenominal) San Diego and San Jose, California, brought training pension reform proposals to local voters in 2012.Proposals call for slashing benefits, and even excrement of delimit benefit pension plans. Understandably, such ideas have met considerable reverse from employees and the unions who represent them. The fact that these are the eighth and 10th largest U. S. cities respectively, means that all States and political subdivisions facing similar fiscal problems will be paying fold up caution to what happens in these two California cities. In the process there has been a lot of finger pointing, largely at labor unions, as politicians and city leaders are slow to admit their knowledge roles in the creation of the crisis.Closer scrutiny may suggest that labor unions are less culpable than the politicians are willing to admit. Purpose and Objective s. The purpose of this determine is to look for some of the challenges in pension reform. We will suggest some guidelines for bringing stakeholders together to deal with the problem. Finally, we will suggest a possible solution to the financial crisis faced by pronounces and their political subdivisions stemming from widespread unfunded pension liabilities. Limitations of our Study. We have not gone into excruciating detail regarding San Diegos pension scandals, though it may have been instructive to do so.neither have we discussed uncounted millions of dollars in wasted legal fees that stemmed from confrontations that tycoon have been avoided, had the city of San Diego interpreted a more cooperative approach toward labor. trance relevant to the present password, these details were a bit beyond the scope of this culture. We looked at a thirteen pension plans as a vox sample. Twelve of these were chosen specifically because they were held out as being typic in the late 1990 s, to support the idea that public solitude systems distance amicable Security.A number of these plans were highlighted in a Pew shew study suggesting that favorable Security should be privatized, quite an than run by the national government. It is noteworthy that, with the exception of just one, all of these non-FICA pension systems are immediately in solemn trouble. Another plan was selected to illustrate just how sad off one State pension system had become, at a lower place(a)(a)scoring the magnitude of the nationwide problem. We did not study the intricacies of each plan to discuss why they have together amassed hundreds of one thousand thousands, or even trillions of dollars in unfunded pension liabilities.We adopt the reasons were common among them all, and that they represent the majority of public sector pension plans in trouble today throughout the United States. We also did not go into great detail to examine the single non-FICA plan that has managed to opera te for several decades without a dime in unfunded pension liabilities. The Galveston County alternative to cordial Security plan is quite unique among public sector pension systems, with totally two neighboring Texas counties following its lead. The plan deserves further study, but this is beyond the scope of our presentation.Even if its ad survival of the fittest were to become widely accepted in the future, however, it would not address veritable issues faced by the nations other public sector retreat systems. Additionally, this study does not fire to examine the legislative steps that may be involved in making any solution work. The U. S. Supreme tribunal has had microscopical to say on the subject of modern pension reform, but we can stomach that to change in the near future as current challenges to State and local pension reforms work their port through the court system.Stay tuned, as it is and a matter of time before the nations highest court will have an opportunity to weigh in on the topic. Summary of Remaining Chapters. In Chapter I we have introduced the concept of pensions, and their place in society as something to which workers are entitled. We have noted that in todays tight fiscal environment, State and local governments have become challenged to continue providing pensions. Chapter II discusses the widespread nature of the problems leading to the call for pension reform nationally. In Chapter III we put hearty Security in perspective.Chapter IV touches upon some of the proposals put forth in the political processes of 2012. Chapter V notes that there are legal and even constitutional implications stand up in the way of draconian pension reforms. In Chapter VI we discuss bringing unions on board to seek solutions in cooperation with management, rather than go along in a pattern of confrontation. Chapter VII discusses one creative way to handle widespread unfunded pension liabilities, and suggests a way to crystallise it work for th e benefit of e actuallyone involved. Chapter VIII closes by offering our conclusions and recommendations. Chapter II Pensions in PerilThere has been much talk in recent months concerning pension reform. At issue is the fact that defined benefit pension plans are unfunded to an alarming degree. This is true nationwide. State and municipal pension funds in many state and local governments currently have less than half of the assets needed to allude their provinces to current and future retirees. The Stanford Institute for Economic Policy interrogation conducted extensive research on California public pension systems, cathartic its report in February, 2012. They analyzed the 24 of the largest public pension systems in 20 California municipalities.While most pension systems nationally release financial reports assuming long term investment returns of near 8%, the Stanford study utilize a more conservative view of 5%. Authors of the Stanford study, Evan Storms and Joe Nation, PhD. , cast the alarming finding that these 24 systems, in aggregate, are alone 53. 6% funded. To illustrate the issue, as of 2010, the San Diego metropolis Employees seclusion arrangement (SDCERS) had increase liabilities of $9. 871 mailingion. This estimate is based upon Stanfords faux discount rate of 5%, a more conservative estimate than the 7. 75% used in SDCERS official projections.The higher the assumed rate of investment return, the lower the liabilities appear. Sugarcoating the issue by making unrealistic assumptions may ultimately make the matter worse. This is notes unavoidable to meet the obligations due current retirees, as well as to meet vested benefits already earned by current employees. To meet this nearly $10 billion obligation, SDCERS has assets only approaching $4. 4 billion. This represents a sustenance ratio of only about 44. 4% of the amount needed to adjoin the citys promises to its employees. According to Stanfords research, the City of San Diegos 2 010 unfunded obligation was $5. 489 billion. Storms & Nation, p. 38) The County of San Diego was similarly situated, with assets of nearly $8. 2 billion to meet accumulated liabilities of $15. 693 billion, a shortfall of nearly $7. 5 billion. (Storms & Nation, p. 28) The City and County of San Diego are by no means unique in the state. The iv pension plans for the City and County of Los Angeles have assets totaling near $70 billion and accrued liabilities of over $90 billion, a $20 billion shortfall. (Storms, pp. 19 and 23) The City and County of San Francisco has assets of close to $16 billion against liabilities of well over $26 billion, or a bit over $10. billion in unfunded liabilities. (Storms & Nation, p. 22) The Stanford study let ind the 24 largest county and municipal pension systems in the State of California and reveals a total aggregate unfunded indebtedness of $135. 7 billion. This represents approximately 46. 4% of the total accrued liabilities of these 24 city and county pension systems. (Storms& Nation, p. vii) The Stanford study examined 2010 results, and suggested that long term investment assumptions in glut of 5% should not be relied upon.On July 21, 2011, the San Diego County Employees solitude Association (SDCERA) announced anterior investment results for fiscal year 2011. SDCERA had managed an outstanding 21% gain. This amazing return added $1. 6 billion to the SDCERA pension fund. Surely the SDCERA Board should be commended on such outstanding results. A few such years can do wonders in restoring this particular fund to health. But just as surely, such results cannot be conveyed to continue each and every year. Neither can other funds rely upon such results. Indeed, few have ever done so well.In 2012 the SDCERA fund realized investment income at the rate of only 6. 5%. While most State retirement systems have reported billions of dollars in unfunded liabilities, Illinois may be the wag child of sickly State sponsore d pensions. As of 2011, the 5 Illinois State pension plans report championship ratios of only 43%, with a total unfunded pension liability of $83 billion. The shortfall in 1996 was only $20 Billion. In the intervening 15 years the unfunded liability work out 4 propagation, from 20 Billion to over $83 Billion, well over $4 billion each year, on average. The nearly $64 billion question How did this happen?This question was studied recently by the civic Committee of the Commercial Club of Chicago. Investment losses, resulting mainly from the mortgage crisis starting in 2007, are estimated by the Committee report to account for nearly 22% of the shortfall. (Civic Committee, p. 11) Investment returns play the major role in pension fund growth, but they are unpredictable, as illustrated in the following chart, taken from the Civic Committee of the Commercial Club of Chicago report on the Illinois State solitude strategy Another major impact comes from changes in actuarial assumptio ns, due to an improvement in mortality rates.This phenomenon may be good for life damages companies, paying less in finish benefits, but defined benefit pension annuities cost more to fund when people are expected to live lengthy, since retirees will collect their pensions for longer periods of time. The Centers for Disease Control and Prevention recently reported that, In the most recent period from 1969 to 2010, monumental progress in the prevention, diagnosis, and treatment of cardiovascular complaints in all likelihood contributed to the 41 per centum decline in age-adjusted mortality. (Hoyert) The drop in mortality rates has been quite dramatic. For all but the oldest age sort (85 years and over), mortality risk fell more than 50 percent between 1935 and 2010. . . For persons 6574 years of age, death rates declined by 62 percent, part death rates decreased by 58 percent for those 7584 years of age, and declined 38 percent for persons 85 years or more. (ibid. ) Apply ing these statistics to pension plans, particularly defined benefit plans with cost of living adjustments (COLAs), it only stands to reason that the cost to keep the retirement checks current to retirees who are living longer, will have a major impact on pension funds.According to the Chicago study, in 1970 a 60 year old was expected to live to the age of 78. By 2007, however, a 60 year old was expected to live to the age of 82. 5. Paying benefits to a 60 year old retiree receiving a pension of $50,000 per year, therefore, has hence increased by over $225,000, estimating that he will be receiving that benefit for about 4. 5 years longer than exponent have been the case 40 years ago. Such variances, multiplied across the hundreds of thousands of articipants in the state pension plans and without corresponding increases in employee contributions, can have a significant impact on the plans unfunded liabilities. (Civic Committee, p. 14) The very(prenominal) phenomenon can be applied to other pension plans throughout the United States. Couple improved mortality factors with reduced investment earnings, and catastrophic losses resulting from the Great Recession. Add to this the fact that states and municipalities are also suffering from dramatic the tax revenue reductions. It cursorily becomes evident that pensions are in peril.The Civic Committee report states that, If Illinois fails to address its pension system through a set of comprehensive and measure reforms, all of its citizens will ultimately suffer. Participants in the netherfunded pension plans will be put at risk. The states ability to provide resilient public services will be severely hampered. And a growth financial burden will be imposed on Illinois residents. (Civic Committee, p. 1) official reports from pension funds throughout the country estimate unfunded liabilities totaling close to a trillion dollars as of mid-2011.That figure, however, is based upon future average investment earnings a t the rate of approximately 8%. While there have been years in which pension systems have attained such a return, or even greater, to rely upon such returns long term, in todays tight economy, may seem unrealistic. Accordingly, such an assumption grossly understates the magnitude of the problem. In July of 2010 the National Center for Policy compend estimated unfunded public pension liabilities throughout the United States in overplus of 3. 1 trillion dollars. Collins & Rettenmaier) Even this estimate may be optimistic. In July of 2012, Andrew Biggs, Ph. D. , a scholar with the American Enterprise Institute in Washington, D. C. , released a report suggesting a more accurate computing for public sector unfunded pension liability may be closer to $4. 6 trillion. (See Table 1) The wide differences among these estimates are accounted for by investment returns, or discount rates, that are more or less optimistic. Andrew Biggs understands pension accounting. He was formerly Principa l Deputy Commissioner of the affable Security Administration.Dr. Biggs holds master degrees from Cambridge University and the University of London, along with a Ph. D. from the London School of Economics. (Biggs) Whether the actual number is 1 or 5 trillion, either number represents a seemingly unsurmountable crisis for public pensions in the U. S. Faced with such a situation, governors, county administrators, mayors, and city councils throughout the nation are seeking creative solutions to handle their part of the shortfall. The imperative call for pension reform has reached crisis semblances in many State and local governments.During the presidential primary resource in June of 2012, the cities of San Diego and San Jose, California, introduced ballot measures seeking voter authorization to reform the pension plans of their respective municipal employees. In both cities the ballot measures were passed by an overwhelming majority of voters, though one might wonder whether the v oters were fully informed. On June 22, 2012, San Jose whitethornor Chuck Reed hand delivered a letter to the U. S. Treasury Department summarizing his Citys fiscal problems as follows San Joses cost for retirement benefits has gone from $73 million ten years ago to $245 million this year.To cope with this increase, we have reduced our work force from 7400 to 5400 employees. We also made many organizational changes to be more efficient, and every employee in the city took a 10% cut in pay. Yet, our unfunded liabilities for retirement benefits continue to grow, and we are facing rising costs for at least another decade. Short of bankruptcy, we have a very limited range of steps we can take to control retirement costs. In attachment to layoffs and pay cuts, we can clap our employees to pay more for the cost of their benefits.Hundreds of cities in California and in other states have already done so. Starting in June 2013 our employees will have to pay an extra 4% of their pay toward s unfunded pension liabilities. That amount will increase annually until it reaches 16% of pay or 50% of the cost of unfunded liabilities. San Diego and San Jose barely represent the tip of the iceberg. The problem, as Mayor Reed suggested, is national. most State and local government pension programs today sense the need for some form of pension reform. Some have been quick to tear the problem on the greed of labor unions. hollow unions have a business to represent their members, and to bargain for the best possible terms and conditions of employment, including pensions. But the unions are not the ones who write the checks or manage public pension funds. Labor unions do not choose to take pension contribution holidays. The most highly equilibrate public employees, those taking the largest pensions, are often not represented by unions. So while unions make wonderful scapegoats, the most grievous of pension abuses that have brought public sector pensions to the brink of insolvency may not lie with unions or their members.Assigning blame to either faction does little to address the problem, and it is not within the scope of this report to point fingers at anyone. Rather we hope to point the way toward a workable solution. sooner looking at proposed or potential solutions we should first understand the role of tender Security. While many public sector employees are not covered under sociable Security, nevertheless, by law their public retirement systems are needful to provide benefits that are at least corresponding to those provided by Social Security. Chapter III Social SecurityNo discussion of pension reform can be complete without an understanding of Social Security, the basis of pension protection for the broad majority of American workers, though certainly not all. On August 14, 1935, Congress passed H. R. 7260, which came to be known as the Social Security Act, signed into law by President Franklin Delano Roosevelt. The intent was to provide a level of economic security measures in the wake of the Great Depression, providing protection for workers and their pendents against the loss of earnings due to disability, retirement, or death.The preamble of the Social Security Act describes it as, An act to provide for the general welfare by establishing a system of Federal old-age benefits, and by enabling the several States to make more adequate purvey for aged persons, blind persons, dependent and gimpy children, maternal and child welfare, public health, and the administration of their unemployment compensation laws to establish a Social Security Board to raise revenue and for other purposes. When first introduced, Social Security covered most common soldier-sector workers. Excluded from reporting, however, were state and local government employees. Prior to 1951, State and political subdivision government employers were not required to participate in Social Security, due to concerns over the constitutionality of imposing fe deral taxes upon sovereign state governments. The Social Security Act was amended in 1950 to add Section 218.This amendment authorized voluntary State liaison through Section 218 Agreements, so named afterwards Section 218 of the Social Security Act The Commissioner of Social Security shall, at the request of any State, enter into an conformity with such State for the purpose of extending the insurance system established by this title to services performed by individuals as employees of such State or any political subdivision thereof. 42 U. S. C. 418 (a)(1) Prior to 1983, continued participation under Section 218 Agreements was optional, with States having the right to bow out from those agreements.Beginning in 1983, however, those public employers which were participating in Social Security were required to continue that participation. The city of San Diego was among many local governments that opted out of Social Security in 1982, prior to the effective date of that change in the law. Throughout the United States today there are approximately 86,000 public employers, with 23 million public employees, according to the Social Security Administrations State and Local Government Employers teaching webpage.Approximately 5 million of those government employees work for public entities that do not participate in Social Security, but rather provide coverage under public retirement systems meeting stringent upright throw requirements. Under current law, Social Security coverage is extended to include employees of state and political subdivisions, unless they are covered under a retirement system that provides benefits that are same to those getable under Social Security.The safe harbor requirements are spelled out in Title 26 of the cypher of Federal Regulations, otherwise known as the Internal Revenue inscribe Under section 3121(b)(7)(F), net incomes of an employee of a State or local government are generally subject to tax under FlCA after July 1, 1991, unless the employee is a member of a retirement system maintained by the State or local government entity. This section 31. 3121(b)(7)2 provides rules for ascertain whether an employee is a member of a retirement system.These rules generally treat an employee as a member of a retirement system if he or she participates in a system that provides retirement benefits, and has an accrued benefit or grows an allocation under the system that is alike(p) to the benefits he or she would have or receive under Social Security. In the case of part-time, seasonal and temporary employees, this borderline retirement benefit is required to be nonforfeitable.In simple terms this means that public employers who do not already voluntarily participate in Social Security under a Section 218 agreement, must now do so unless they provide benefits under a public retirement system which are at least as comprehensive and beneficial as those provided under Social Security. This is not a discretionary it em, where a public employer may give its employees an option to participate or not. The employer must either participate in Social Security, or provide its employees with a retirement system that provides benefits which are comparable with(predicate) to the benefits he or she would have or receive under Social Security. Another friendliness is that Social Security OASDI benefits include a great deal more than a simple retirement plan paying retirement income to its participants. Social Security also offers income to a workers dependent children until their age 18. There is also a disability income insurance element within Social Security, which is either non-existent or difficult to provide under a typical 401(k) style plan. 401(k) plans are investment vehicles that require the element of time in order to grow. Disability can strike at any time, and may not wait for a workers 401(k) plan to gain adequate resources.Disability income insurance costs are occupationally based. The gre ater the physical demand upon the worker, and the more hazardous an occupation is, the greater the cost to provide insurance coverage. Sanitation workers and safety employees, police officers and firefighters, for physical exertion, face physical demands and hazards that do not exist for clerical workers and executive level department heads. To replace the disability benefits guaranteed under Social Security through a plan of insurance, whether self-funded or through commercial insurers, would add a tremendous drain upon the resources of a Defined region plan.In contrast, Social Security spreads that risk across all workers nationally, regardless of occupational hazards. In the private sector nearly all employees are subject to payment of Social Security payroll taxes under the Federal policy characters Act (FICA), and pensionable for coverage under Social Securitys Old-Age, Survivors, and Disability Insurance (OASDI). But approximately 5 million public employees in the United S tates are exempt from Social Security coverage, since their employers opted out of Social Security before 1983.As discussed above, Public employees may be exempted from Social Security, provided they are members of a retirement system maintained by a state or political subdivision. To be exempt from Social Security coverage, the retirement system must provide certain minimum retirement benefits. To meet the minimum requirement, IRS regulations require that a retirement system provide benefits to the employee that are comparable to those provided in the Old-Age portion of the OldAge, Survivor, Disability Insurance (OASDI) program under Social Security. IRS Publication 963) Public employees who participate in a retirement system that meets the minimum requirements are said to have safe harbor. Such a retirement plan may be either a defined benefit or a defined contribution plan, but benefits derived from the plan must be comparable to those operational under Social Security. In other words, any public pension plan that fails to provide retirement and disability benefits at least as good as those provided under OASDI, also fails to exempt the pubic employer from participating in Social Security.Drastic changes to public retirement systems may disqualify municipalities from continued safe harbor. Another consideration those anxious for reform may be overlooking is that this is an all-or-nothing proposition. Cities imposing major pension reforms limited to new hires may find that the new employee plan fails the safe harbor test, thus requiring Social Security participation from all employees, including those not previously covered. While this remains to be tested in the courts, the law seems pretty clear on this issue. Social Security has had its detractors from its very beginnings.Many people have believed private investment strategies could produce greater financial security than the government run Social Security program. Some have called for Social Security Pr ivatization. In 1997, William Even and David MacPherson published a study that examined 7 public retirement systems not participating in Social Security, referred to as non-FICA plans. The study suggested that these 7 plans would provide greater retirement benefits than Social Security to the million covered employees. (Even MacPherson) In 1999, the Cato Institute published the Cato Project on Social Security Privatization.This study examined several other non-FICA public retirement systems administered by local governments, including the San Diego City Employees retirement System (SDCERS), the mama Teachers seclusion System, the Louisiana Police seclusion System, the Louisiana Firefighters retreat System, the Public Employees Retirement System of Ohio, the alternate Plan for Galveston County Employees. (Lips) At the time of these studies, each of the dozen retirement systems featured in were thriving, and reportedly capable of providing far greater benefits to their beneficia ries than would have been available under Social Security.They were spotlighted to illustrate that such funds were outperforming Social Security as a means of providing retirement security for public employees. In Chapter II we mentioned that as of 2011, according to a report published by the Stanford Institute for Economic Policy Research, the San Diego City Employees Retirement System (SDCERS) only had assets of $4. 4 billion to cover accrued liabilities of $9. 871 billion, an unfunded liability of $5. 489 billion. Due to differences in projected investment returns, these figures differ dramatically from the official numbers released in SDCERS financial reports.SDCERS reports their unfunded liability at under $2. 2 billion. Either way you slice it, whether $2 billion or $5 billion, this is a great deal of money for any single municipality to come up with. Whichever figure you prefer to accept, the fund is no longer the healthy pension system it was at the time of the 1999 Cato stu dy. The SDCERS fund was then considered among the best public employee retirement systems in the country, an example used to raise the idea of Social Security privatization. Today it has an unfunded pension liability approaching 56%. Select Unfunded Accrued Pension Liabilities Non-FICA Public Retirement System UAL (billions) Funded Ratio % 1 San Diego City Employees Retirement System (SDCERS) 2. 1 68. 5 2 Los Angeles City Employees Retirement System (LACERS) 3. 7 72. 4 3 Maine Public Employees Retirement System (Maine PERS) 4. 1 66. 0 4 Ohio Public Employees Retirement System (OPERS) 67. 8 63. 0 5 State Teachers Retirement System of Ohio (STRS Ohio) 40. 6 58. 8 6 Colorado Public Employees Retirement System (PERA) 30. 0 7 Nevada Public Employees Retirement System (NVPERS) 10. 9 70. 2 8 California State Teachers Retirement System (CalSTRS) 65. 69. 4 9 Massachusetts Teachers Retirement System 13. 6 58. 7 10 Louisiana Police Retirement System 0. 3 55. 6 11 Louisiana Firefighters Ret irement System 0. 4 74. 3 12 The Alternative Plan for Galveston County Employees 0. 0 100. 0 239. 0 With the exception of one, each of the other public retirement systems cited in the 1997 and 1999 studies are today facing massive unfunded liabilities. Based on their own 2010 or 2011 financial reports, 10 of those 11 retirement systems are facing total unfunded accrued actuarial liabilities (UAL) of $239. 0 billion. 1.As of June 30, 2011 the unfunded actuarial liability (UAL) of the San Diego City Employees Retirement System (SDCERS) was 2. 1778 billion, a funding ratio of 68. 5%. Those are SDCERS own estimates. As shown above, however, reducing the assumed investment income rate to 5% changes the funding ratio to 44% and suggests an unfunded liability of between $5 and $6 billion. 2. The Los Angeles City Employees Retirement System (LACERS), administers pensions for employees of the City of Los Angeles, a city with an annual budget of near $7 billion. As of April, 2012, the fun d reported $27 billion in unfunded pension liabilities. source http//www. calwatchdog. com/2012/04/30/los-angeles-teeters-on-the-brink-of-bankruptcy/ 3. As of May 24, 2011, the Maine Public Employees Retirement System (MainePERS) reports an unfunded accumulated liability (UAL) of $4. 1 billion in the MainePERS State/Teacher Plan, amortized at a 2-year cost of $689 million on top of normal contributions of $159 million. as reported by letter to Senator Richard Rosen and Representative Patrick alluvion of Maines Joint Standing Committee on Appropriations and Financial Affairs, May 24, 2011 4.As of April 2, 2011, the Ohio Public Employees Retirement System (OPERS), with its 5 pension plans, including the Highway patrol Retirement System, the Ohio Police and Fire Pension Fund, the Ohio Public Employees Retirement System, the State Teachers Retirement System, and the School Employees Retirement System, has a total unfunded pension liability of $67. 8 billion, against assets of $115. 5 b illion. That makes Ohios pensions only 63% funded. source http//sunshinereview. org/index. php/Ohio_public_pensions 5. The State Teachers Retirement System of Ohio (STRS Ohio) reported an unfunded liability of 40. 5 billion, as of November 10, 2011. https//www. strsoh. org/ On September 26, 2012 Ohio Governor Kaisich signed the Ohio pension reform bill passed by the Ohio Legilature on September 12, intending to improve the financial condition of its five Ohio pension systems. The bill continues to support Ohios Defined take in Pensions as major economic drivers for the state, and providing a stable retirement income for public workers in Ohio. https//www. strsoh. org/legislation/main. html At Ohio State University, faculty contribute 10% of their allowance to the retirement plan, while the university contributes 10. % of the faculty members salary to his or her retirement plan. An superfluous 3. 5% of salary is contributed to STRS to reduce unfunded liabilities. http//hr. osu. e du/benefits/rb_strs. aspx 6. The Colorado Public Employees Retirement System (PERA) faced a 30 billion unfunded liability in 2010. 7. The Nevada Public Employees Retirement System (NVPERS) has assets of $25. 8 billion, and has generated a net return of 9. 3% over its 28 year existence, exceeding its actuarial objective of 8%. That sounds great, until you realize that returns over the past 5 years average closer to 2. %. The Nevada PERS estimates its funded ratio at 70. 2% for 2011, its final level since its 1992 inception. This leaves the plan with an unfunded liability of 10. 95 billion. 8. California State Teachers Retirement System (CalSTRS), 152. 2 billion in assets, as of June 30, 2011, had an unfunded liability of $65. 5 billion, representing a funding ration of 69. 4%. source Pensions Investments Research Center, April 9, 2012, available at http//www. pionline. com/article/20120409/REG/120409899 9. The Massachusetts Teachers Retirement System has one of the lowest cost o ta xpayers, with employees required to fund the greatest portion of their own retirement. New employees pay 95% of the cost of their pensions. But the system still faces an unfunded pension liability of $13. 6 billion against assets of 19. 4 billion, in 2009, with a funded ratio of just 58. 7%. 10. The Louisiana Police Retirement System is a small system with assets of only $360. 9 million, but its unfunded liability is $313 million. Its funded ratio is only 55. 6%. 11. The Louisiana Firefighters Retirement System, as of June 30, 2011, had an unfunded actuarial accrued liability of $416,177,743, against assets of 1. billion. This fund has a funded ratio of 74. 33%, which is very good compared to the rest of Louisianas retirement systems, facing a total shortage of 18. 5 billion, with a funding ratio of 56%. 12. The Alternative Plan for Galveston County Employees is unique among the reviewed plans, claiming no unfunded pension liability. This plan was patterned after Social Security, p rofession for the same level of contribution as with Social Security, from the employer and the worker alike. The plan also incorporates an insurance element that improves on the theme from Social Security.In addition to retirement benefits that a near double those of Social Security, Galvestons Alternative Plan pays a death benefit equivalent to four times a workers annual salary. Two neighboring Texas counties select similar retirement plans in 1983. The Galveston model stands alone among all of the public retirement systems included in the 1997 and 1999 studies used to support the idea of privatizing Social Security. Galveston Countys approach seems worthy of further study and emulation, as a plan fair to participants, employers, and taxpayers alike.Chapter IV Reform mesmerisms In the past dozen years, since the disaster of 9/11/2001, and especially since the mortgage industry nuclear meltdown in 2008 and 2009, pension reform has become an increasingly pressing issue. Some muni cipalities, including San Diego, and San Jose, California, have passed ballot measures calling for pension reform. These were known as Proposition B in San Diego, and Measure B in San Jose. San Diego and San Jose are the 8th and 10th largest cities in the U. S. respectively, so what happens in these communities with respect o pension reform will gain the attention of all cities throughout the nation that are seeking solutions to the problem of unfunded pension liabilities. San Diegos City study included a provision that requires a majority vote of all city employees to approve any changes to retirement benefits. Proposition B called for that provision to be eliminated from the City Charter. (Prop. B) The ballot measure was intended to create a voter-supported mandate, granting the Mayor and the City Council authority to modify the Citys pension plans. These make up a major part of the compensation packages of city government workers.If the City denies its employees voting rights ov er control of their pensions, such a move could have serious property right implications. capital punishment of such a plan may lead to very pricey legal battles for reasons we have explored in previous chapters. Among the most fundamental of employee benefits upon which the vast majority of U. S. workers have come to rely is the Social Security system, which we discussed in Chapter III. Social Security ensures a degree of financial stability to retired workers, or in the event of a disabling injury or disease that would prevent a worker from earning a living.This basic employee benefit has been a part of American workers life since passage of the Social Security Act of 1935. The act instituted a system of mandatory old-age insurance, issuing benefits in proportion to the previous earnings . . . and establishing a reserve fund financed through the fabrication of payroll taxes on employers and employees. (Farlex) But what many voters may not have realized when they supported Pro position B in June of 2012, is that participation in Social Security is among the sacrifices San Diego employees made in accepting careers with the City.As explained in Chapter III, while virtually all private sector employers are required by law to participate in Social Security for the benefit of their employees, only some local government entities are exempt. The City of San Diego elected to withdraw from Social Security participation in 1982, and since then has not paid Social Security payroll taxes. Instead, San Diego and many similarly situated municipalities provide retirement and disability related financial security to its employees through the Citys pension plan.San Diego City employees are only eligible to receive Social Security retirement benefits if they worked in covered employment other than for the City of San Diego, or worked for the City prior to 1982. Instead, San Diegos employees are covered only by the public retirement system provided by the City. Public emplo yees in many other cities across the nation work under similar circumstances. But since the vast majority of voters are covered by Social Security, it probably does not occur to them that local government workers are not eligible.While pension reform became a political football in San Diegos 2012 mayoral campaign, pension issues have plagued the City of San Diego for over a dozen years. One of the four mayoral medical prognosiss, City Councilmember Carl DeMaio, wrote and promoted Proposition B, which was placed on the ballot for the presidential primary election held on June 5, 2012. oft controversy surrounded this ballot measure, following allegations that the City had circumvented the legally required process of meeting and conferring with its labor unions.Both outgoing Mayor Jerry Sanders and City Councilmember Carl DeMaio openly claimed authorship of the ballot scuttle. Mr. DeMaio made it a key element of his mayoral campaign. But when the City was challenged as to its fail ure to negotiate with the Citys union concerning proposed reforms, they both claimed the initiative was citizen-initiated, and not an action of the City. Since both the mayor and a prominent member of the City Council each played a major role in the authorship and promotion of the initiative, it seems difficult to legitimatize the claim that this was not an official action of the City.As the ballot measure was presented to the voters, however, supporters of the initiative failed to mention or remind voters that San Diegos pension plan had replaced Social Security for City employees 30 years before. Had voters understood the full ramifications to City workers, and the fact that they are not covered by Social Security, the election results on Proposition B may have been different. Indeed, had the voters who signed petitions to have the measure placed on the ballot known this vital detail, some may have withheld their signature.Promoters carefully avoided any discussion of Social Secu rity as they cajoled voters to pass the measure, while opponents also failed to adequately stress the Social Security implications. Legal challenges were brought in the courts, charging that the City violated its legal obligation under the Meyers-Milias-Brown Act to meet and confer with the Citys unions regarding furnish of the ballot initiative. The City won the first round in this battle, succeed in getting the measure placed on the June 2012 ballot. In San Diego municipal Employees Association v.The Superior Court of San Diego County (San Diego County Superior Court No. 37-2012-00092205-CU-MC-CTL), the Court of Appeal for the Fourth Appellate District overruled that decision, but too late to have any impact. That decision came on June 19, 2012, two weeks after the election. The proposition that San Diegos Proposition B had a questionable legislative history, or that it was improperly brought to a public vote, is not to imply that pension reform is unnecessary, in San Diego or a nywhere else. But Proposition B may not be the panacea San Diego voters were led to expect.There may be other actions San Diego can take to address its pension problems actions that would be both more effective and more fair to City employees and taxpayers alike. Several such potentially more sensible approaches to the problem were mentioned by Congressman Bob Filner, the only one among San Diegos four mayoral candidates who resisted Proposition B. Congressman Filner accepted the propositions shaky legal foundation, and acknowledged that such a reform plan may meet with constitutional challenges we will explore in the next chapter.Proposition B involved several elements. One part of Proposition B imposes a wage turnze. Curiously, however, even after the wage freeze was announced, Mayor Sanders authorized pay raises for several members of his administration, totaling nearly $45,000 per year. Union officials might wonder why austerity measures like wage freezes fall in to represen ted employees, but apparently not to another class of employees. If serious belt-tightening is called for, the City might do well to apply such measures universally.To expect the burden to be borne by the Citys unionized workers, but not by management employees, does not do much to promote labor peace. The proposition also modifies the police pension plan, raising the retirement age and lower the maximum benefit. Pension benefits for newly hired public safety workers would be reduced from a maximum of 90% to a lower cap of 80% of pre-retirement earnings. Key among the changes imposed by Proposition B is replacing the Citys Defined Benefit pension plan with a 401(k) style Defined Contribution plan that make no financial security guarantees.These would be for all new employees who are not a part of the Police Department. As to Social Security, close reading of Proposition B reveals that its author acknowledges the fact that City employees are not presently covered. It is suggested tha t the City may open the option for employees to become covered by Social Security, but that it is the intention of the City to maintain its safe harbor exemption from Social Security participation. In this respect San Diegos Proposition B approach to pension reform may have a fatal flaw.Recall from our discussion of Social Security that municipalities can maintain exemption from participation in Social Security, but only if its pension plan provides benefits comparable to those available under Social Security. For the past 30 years the Citys Defined Benefit pension plan has fulfilled that requirement. The question is, will the 401 (k) style Defined Contribution plan proposed under Proposition B, meet the same stringent requirements? Unless the plan provides a level of benefits at least as comprehensive as Social Securitys Old-Age, Survivors, and Disability Insurance (OASDI), the answer is likely no.Defined Benefit Pension plans base pension benefits as a guaranteed primed(p) percen tage of pre-retirement income, determined by a benefit formula that considers both rates of pay and years of service. These benefits are paid for by employer and employee contributions to the pension fund, and also by the investment income derived from the fund. When fund investments do well, contributions required from the employer are lessened. When investment income suffers, greater contributions are required from the employer to meet fund obligations.Defined Contribution Plans, in contrast, do not feature benefit guarantees, but rather base their security in a known fixed cost for the amounts paid into the plan. (Bennett-Alexander, p. 774) Defined Contribution plans may seem glossy from the point of view of the employer, but for the worker it means financial uncertainty. Eliminating the financial security features of Defined Benefit plans is a major change from long-standing past practice in San Diego and in cities similarly situated.The principle of past practice may give yet another basis upon which unions may mount a challenge to such a drastic change as to eliminate participation in Defined Benefit plans. Defined Benefit Pension Plans account for nearly 73% of union-negotiated retirement plans across the Nation, particularly in the public sector. (Carrell, p. 329) Income maintenance plans pensions and other employee benefits such as severance pay, death and disability insurance, wage guarantees, supplemental unemployment plans, and the like have generally been negotiated over long periods of collective bargaining by employee organizations and unions. Carrell, p. 328). In many cases, such as for San Diego city employees, these negotiated income maintenance plans take the place of programs made available to other workers through Social Security. Based upon ones term of employment and level of earnings, Social Securitys OASDI provides guaranteed disability and retirement income to covered individuals and their families. Defined Benefit pension plans ca n be designed to be as good or better than Social Security. Benefits under Social Security are not in any way dependent upon investment returns, and the same is true, by definition, in Defined Benefit pension plans.The very nature of a Defined Benefit plan is that what is defined is the benefit, not the contribution. Benefits are established, and contributions may vary to meet the schedule benefits. If investment returns fail to fund the plan at sufficient levels to meet plan obligations, the shortfall is simply overcome by making greater contributions to the plan. In a Defined Contribution plan, however, what is guaranteed is not the benefit, but rather the amounts to be contributed. Costs are fixed benefits are contingent upon the funds resources, which come both from contributions and investment earnings.Simply put, benefits are directly dependent upon investment returns, which cannot be guaranteed. Highly compensated employees (HCE) see another attractive feature of 401(k) style retirement plans. Participating in such a plan offers very significant tax benefit, allowing voluntary contributions to accrue free of income taxes. Those workers whose income is lower, however, can neither afford voluntary reductions in pay, nor benefit to the same degree from 401(k) plan participation.From the perspective of lower paid workers, particularly those younger workers who do not sense retirement planning as being pertinent, every dollar an employer pays into a pension plan is a dollar that is not available in this weeks paycheck. While as true for the highly compensated, that dollar has less significance. As explained in a recent study by the Center for Retirement Research at Boston College, high income workers benefit disproportionately due to higher participation rates, higher contribution rates, and higher tax benefits. Toder and Smith, p. 7) Defined Contribution plans may appear attractive to public employer budget analysts and some highly compensated employees, but they almost certainly fall short of being comparable to Social Security. To make them comparable, contribution rates would likely have to be set so high as to make investment returns unimportant. curtly then, Defined Contribution plans lose their attraction, as they may cost even more than the Defined Benefit plans they are intended to replace.That may be even more true considering the attorney and court fees taxpayers may be required to suffer to defend legal and constitutional challenges. During the San Diego mayoral race, candidate Congressman Bob Filner, noted that should Proposition B be implemented, there is a strong likelihood that much of the perceived savings might be spent instead on legal fees defending the lawsuits that would likely follow. Discussing the pension reform problem on the National scene, and the move toward pillowcase back on pension benefits, Stuart Buck, J. D. as noted, The problem is how to do this in a way that is most fair to workers and in a way that is consistent with state or federal Constitutional provisions that forestall states from impairing the obligations of contracts. (Buck. ) Chapter V Legal and Constitutional Hurdles Power to grant pensions is not controverted, nor can it well be, as it was exercised by the States and by the Continental Congress during the war of the Revolution and the exercise of the power is coeval with the organization of the government under the present Constitution, and has been continued without interruption or question to the present time.Justice Nathan Clifford United States Supreme Court United States v. Hall 98 U. S. 343 (1879) The proof of pensions in recognition of public service is a practice so steeped in tradition as to be considered a right of passage. whatsoever proposal that suggests taking such benefits away from public servants will be met with stern opposition in the courts. There are well-founded statutory, contractual, and constitutional protections that make it difficu lt for cities or other political subdivisions to impose pension reforms. The U. S.Constitution has several clauses that can be interpreted to protect pensions. Numerous State constitutions offer similar protections. San Diego Pension Issues The City of San Diego, California, presents an interesting backdrop for the discussion of the legal and constitutional implications of pension reform. During the past decade the City of San Diego incurred millions of dollars in legal expenses dealing with lawsuits stemming from scandalous pension dealings and futile attempts to make unilateral changes to its pension plans.Such money enriched a few lawyers, but only worked against the interests of the City and its taxpayers. Attempts by the City of San Diego to impose pension reforms again gained attention during the 2012 election year. One of the Citys mayoral candidates, City Councilmember Carl DeMaio, wrote a ballot proposition known as the Comprehensive Pension Reform Initiative, making pensio n reform the basis of his campaign. Of the four candidates in the 2012 San Diego mayoral race, only Congressman Filner seemed to acknowledge the legal and constitutional issues applicable to pension reform.During the campaign, candidate Bob Filner, a 20 year veteran of the U. S. domiciliate of Representatives, predicted that should Mr. DeMaios Proposition B pass voter approval, its implementation would be met by legal and constitutional challenges that may cost the City in a heartfelt way to defend. Mr. Filner also noted that, Proposition B does nothing to reduce the current pension deficit, it takes retirement security from employees who are not in the Social Security system and it will result in years and years of more political wrangling and litigation over its legality and implementation. (Filner) Specifically, the legal implications of Proposition may involve charges of breach of contract. Under California law, employers enter into an implied and enforceable contract with em ployees as of the date of hire, with respect to the terms and conditions of employment. Employee benefits, including pensions, that are promised as an inducement to accept em