The problems facing public agencies, many of which are struggling just to keep their heads above water, may get much worse in the near future.  The California Legislature is currently debating Senate Bill (SB) 278 (Leyva), which if passed would create new and in some cases retroactive financial burdens and uncertainties for local public agencies already struggling to fund their pension obligations. Specifically, SB 278 would shift the responsibility for paying disallowed compensation reported to the California Public Employees’ Retirement System (CalPERS) directly to local public agencies.

For context, the Public Employees Retirement Law (PERL) provides a defined benefit retirement plan for public agency employees administered by CalPERS.  The Public Employees’ Pension Reform Act of 2013 (PEPRA) made changes to the categories of compensation that can be included in an employee’s retirement benefit calculation.  Compensation items used for retirement benefit calculations are often specified in collective bargaining agreements and are the product of negotiated agreement.  However, the statutes, regulations, and administrative guidance concerning which items are reportable are complex and can be confusing, which sometimes leads to reporting errors.

Under current law, if CalPERS determines that a disallowed item of compensation was included when determining a retiree’s retirement benefit allowance, the retiree has to pay CalPERS back the amount of overpayment, and future retirement allowance payments are reduced prospectively based on what the retiree would have received if the improper item of compensation had not been included.  CalPERS generally may collect amounts that were overpaid within the last three years.  In a nutshell, the individual must pay back and stop receiving that which they were never entitled to in the first place.

If passed, SB 278 would require local agencies to pay CalPERS the full cost of any overpayments made to the retiree based on the disallowed compensation and provide an annuity or lump sum payment to make the retiree whole for any reductions in future benefit payments.  The statute would apply to any determinations made on or after January 1, 2017, if the appeal rights of the retiree have not been exhausted.  Importantly, it appears a CalPERS determination made on or after January 1, 2017, could potentially apply to decades of misreported compensation before then, and in many cases would impact an entire bargaining group covered by a particular labor agreement.  This may very well incentivize CalPERS to start aggressively auditing local agencies, because any unfunded liabilities for inadvertently misreported compensation would be shifted directly to the employer.  The potential retroactive liability for public employers could be significant – and impossible to predict.  While SB 278 has a provision for CalPERS to review labor agreements prospectively and provide guidance, CalPERS would not be bound by its guidance.  The statute also fails to address past reported compensation that may result in significant retroactive liability.

For current employees, SB 278 does not make significant changes, as it allows improper contributions to act as a credit towards a public agency’s future contributions, and any contributions paid by the employee(s) on the disallowed compensation are returned.

Whether SB 278 becomes law is a decision that will likely fall on Governor Newsom’s shoulders.  A similar proposal – SB 1124 (Leyva) – was passed by the Legislature in 2018, but it was vetoed by Governor Brown.  In his veto message, Governor Brown said he was concerned the bill could be “abused to circumvent limitations in the law intended to protect the government—and ultimately taxpayers—from pension spiking.  Indeed, in the case of an error, this bill would effectively perpetuate that error for the rest of the member’s life, at substantial taxpayer expense.”  Governor Brown encouraged the Legislature to develop policies that would prevent such errors from occurring in the first place, including having CalPERS review proposals for pensionable compensation in memorandums of understanding before the memorandum is finalized.  If the error occurred after that process, penalties might then be warranted.  The current version of SB 278 fails to seriously address Governor Brown’s guidance.  Another similar bill, SB 266 (Leyva), was withdrawn and held at the desk after it passed the Legislature in 2020.

SB 278 suffers from the same problems as its predecessors.  It will lead to whole new category of litigation, does not address concerns with retroactivity and would require public agencies and taxpayers to shoulder the responsibility for reporting mistakes that may cause further crowding out of government services.

Regardless of whether SB 278 becomes law, public agencies should review each item of compensation reported to CalPERS to ensure that the item is reportable under applicable statutes, regulations, and administrative guidance.