This guest post was authored by Alison Neufeld

Public sector pension reform has been a hot topic for months. But despite the public focus on the Governor’s 12-Point Pension Reform Plan, voter initiatives, charter amendments, litigation and bankruptcies fueled by unfunded pension liabilities, time seemed to be running out for pension reform during the current legislative term.  The Legislature adjourns at midnight on Friday, August 31, 2012.

That changed on Tuesday, when Governor Brown and Democrats issued a press release announcing they had reached an agreement on public employee pension reform at the state level.  At an eleventh-hour hearing of the joint Conference Committee on Pension Reform at the State Capitol on Tuesday evening, the Conference Committee introduced the California Public Employees’ Pension Reform Act of 2013 (“CPEPRA”).

Copies of the CPEPRA, which was introduced as an amendment to AB 340, were released to attendees at the hearing.  The Conference Committee approved the proposed legislation to be voted on by the State Assembly and Senate on Friday.

LCW attorney Gage Dungy, who was in attendance at the hearing on Tuesday evening, observed:  “The hearing was packed and a little bit chaotic.  Even the Assembly Members and Senators on the committee readily acknowledged that they literally had just received the CPEPRA proposed language and had not yet read it.”  

The CPEPRA addresses most of the points raised in the Governor’s 12-point plan, but does not provide for a “hybrid” plan with a 401(k) component, or address the reduction in retiree health costs for State employees sought by the Governor. 

If approved, CPEPRA will take effect on January 1, 2013.  In a Special Bulletin issued yesterday, we discussed the impact of the CPEPRA on public school and community college district participants in the State Teachers Retirement System (CalSTRS).  Highlights of the proposed legislation for public agencies are outlined below:

• Broad Coverage: The CPEPRA is intended to apply to all public agencies with the exception of the University of California and charter cities and counties that have their own independent retirement systems. 

  Aside from these exceptions, the CPEPRA covers all state and local public retirement systems including the California Public Employees’ Retirement System (CalPERS), retirement plans governed by County Employees Retirement Law of 1937 (the ‘37 Act), CalSTERS, the Legislators’ Retirement System and the Judges’ Retirement Systems I and II, as well as individual retirement plans offered by public employers and defined benefit governmental plans under Section 401(a) of the Internal Revenue Code. 

  Most of the provisions of the CPEPRA apply to public employees defined as “new members” – i.e., individuals hired after January 1, 2013, who have never been members of a public retirement system; individuals who move between retirement systems with more than a six-month break in service; and individuals who move between public employers within the same retirement system after a six-month break in service.  Certain provisions of the CPERA apply to both current and new members.

• Reduced Benefit Formulas for New Members: The available retirement formulas for “new members” hired after January 1, 2013, will be limited.  CPEPRA establishes a single defined benefit formula for new nonsafety (miscellaneous) members and three defined benefit formulas for new safety members. 

  The retirement formula for nonsafety members, with the exception of teachers, is 2% at 62. 

  The three formulas for safety members are: the Basic Safety Plan (2% at 57); the Safety Option Plan I (2.5% at 57); and the Safety Option Plan II (2.7% at 57).  Employers must offer new safety members the formula that is closest to and provides a lower benefit at 55 years of age than the formula provided to members in the same retirement classification offered by the employer on December 31, 2012.

  Employers will be prohibited from providing new members with a supplemental defined benefit plan.

• Increased Retirement Ages for New Members: The retirement age for full retirement benefits will be raised to 67 for nonsafety members and to 57 for safety members.
• No Retroactive Enhancements to Benefit Formulas:  Enhancements to a benefit formula that are adopted or apply to a member on or after January 1, 2013, may only be applied to the member’s future service.
• Requires Equal Sharing of Normal Costs:  New employees are required to pay least 50 percent of annual normal costs.  Employers are precluded from paying any part of the required employee contribution.  Normal cost is defined as the portion of the present value of projected benefits under the defined benefit plan attributable to the current year of service, as determined by the public retirement system’s most recent actuarial valuation. 

  Unfortunately, the steep increases in most public employer’s employer contribution rate in recent years has been due to the increase in unfunded liability, not annual normal cost.  

  Employee contributions may be more than one-half of the normal cost rate, but only if the increase has been agreed to through the collective bargaining process.  Employers may not use the impasse process to increase an employee contribution rate about the 50 percent equal sharing standard.  Nor may employers contribute at a greater rate to the plan for nonrepresented, managerial or supervisory employees than for represented employees.   

  The CPEPRA includes a grandfather clause when the terms of a contract or MOU between a public employer and its employees in effect on January 1, 2013, would be impaired by the requirement that normal costs be equally shared.  In that case, the requirement will not apply to the parties until the expiration of the contract.  However, any renewal, amendment or other extension of the contract will be subject to the equal sharing requirement.  

• Caps Pensionable Compensation for New Members: The amount of compensation used to calculate pension benefits for new members is limited to no more than the Social Security wage index limit ($110,100) for employees who participate in Social Security, and 120% of that amount ($132,120) for those employees who do not.  Retirement systems must adjust the cap each year based on changes in the Consumer Price Index (CPI) for all Urban Consumers.  The Legislature may make prospective changes to the annual CPI adjustments as long as the change does not result in a decrease in an employee’s accrued benefits. 
• Pensionable Compensation: For “new members,” pensionable compensation means the normal monthly rate of pay or base pay of the member.  Pensionable compensation does not include payments made for the purpose of increasing a member’s retirement benefit; in-kind compensation; one-time or ad hoc payments; severance or other payment made in anticipation of a separation from employment; payments for unused vacation, annual leave, personal leave, sick leave, or compensatory time off; payments for additional services rendered outside of normal working hours; any employer-provided allowance such as one made for housing, vehicle, or uniforms; compensation for overtime work, other than as defined in Section 207(k) of Title 29 of the United States Code; employer contributions to deferred compensation or defined contribution plans; any bonus paid; or any other form of compensation a public retirement board determines should not be pensionable compensation.
• 36-Month Final Compensation Period: To end the practice of “spiking,” which can occur when compensation is increased in the final 12-months of service to increase the retirement benefit owed, final compensation for new members will be determined based on the highest average annual pensionable compensation earned over a consecutive 36-month period.  Effective January 1, 2013, employers cannot modify benefit plans to permit calculation of compensation on the basis of less than a consecutive 36-month period for existing employees.
• Employers May Continue to Offer Defined Contribution Plans And Certain Defined Benefit Plans:  If an employer offers a retirement plan consisting solely of a defined contribution plan that was in place before January 1, 2013, the employer may continue to offer that plan instead of the defined benefit plan required by CPEPRA.    

  Employers may continue to offer defined benefit plans that provide lower defined benefit formulas, and result in a lower normal cost, than required by the CPEPRA.  Effective January 1, 2013, new defined benefit plans or formulas must either conform to CPEPRA or be certified as having no greater risk or cost than the defined benefit formula required by CPEPRA, and must be approved by the Legislature. 

• Cost Sharing Agreements for CalPERS Agencies: CalPERS agencies that reach agreements with employee organizations to share some portion of the employer contribution under Government Code section 20516.  Such cost sharing agreements must be applied to related nonrepresented employees as approved in a resolution passed by the contracting agency.   

  CPEPRA adds Section 20516.5 to the Government Code, prohibiting CalPERS agencies from utilizing impasse procedures to impose cost sharing arrangements that require employees to contribute in excess of the amount required by law for the first five years after CPEPRA goes into effect.

  Beginning in January 2018, employers may require employees to pay at least 50 percent of normal costs after meeting and conferring in good faith and exhausting impasse procedures.  However, the employee contribution may not exceed specified percentages of pay for the various retirement categories. 

  CPEPRA caps employer contributions to any public retirement plan.  For new members, employers are prohibited from making contributions on any amounts of compensation that exceed the limit established by Internal Revenue Service Code (IRC) Section 401(a)(17).  For tax year 2012, that limit is $250,000.

• No More Purchase of “Air-Time”: CPEPRA prohibits the purchase of non-qualified permissive service credit (“air time”) on and after January 1, 2013. This category includes service credit for periods for which there is no performance of service and may include service credited in order to provide an increased benefit under the plan.
• Securing Retirement Systems for the Future: CPEPRA would prohibit employers from suspending employer and/or employee contributions necessary to fund the annual normal cost rate of the pension.
• Limitations on Post-Retirement Employment: CPEPRA forbids post-retirement employment, without reinstatement, for a period of 180 days after the employee’s date of retirement from the public retirement system with certain exceptions.  A retiree is limited to performing a cumulative 960 hours of work in a 12-month period for all employers in the same public retirement system.  If a retiree has received any unemployment compensation, he or she is prohibited from working for the next 12-month period for any public employer.  CPEPRA incorporates the requirement established for CalPERS agencies under AB 1028 that a retiree’s rate of compensation may not to exceed the maximum paid to current employees performing comparable duties.  Retirees would be ineligible for another reappointment under the section for the 12-month period following the end of the first appointment.
• Forfeiture of Pension Allowance Upon Conviction Of a Felony: The law proposes a strict standard for public officials and public employees convicted of a felony while performing official duties, while running for elected office or seeking appointment, or if the felony involves an attempt to wrongfully obtain salary or pension benefits: the convicted felon would forfeit pension and retirement-related benefits.

This Special Bulletin highlights some of the more significant portions of CPEPRA at this time.  There may be further changes to the language of the proposed legislation before the vote on Friday, and there is no guarantee that the bill will pass.  We can only wait and see what the Legislature will do before the end of this legislative session.  As always, we will keep you posted.