On September 27, 2021, Governor Newsom signed Senate Bill (SB) 278, which adds Government Code section 20164.5 and will go into effect on January 1, 2022. SB 278 greatly increases the potential costs to CalPERS agencies for reporting errors, by creating new and in some cases retroactive financial exposure for CalPERS agencies already struggling to fund their pension obligations. Specifically, SB 278 would shift almost all of the consequences for reporting later disallowed compensation to the employer.

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 some employees’ retirement benefit calculation.  The statutes, regulations, and administrative guidance concerning which items are reportable are complex and can be confusing, which sometimes leads to unintended reporting errors.  In addition to the complicated regulatory scheme, the items of compensation are often the product of negotiations, which sometimes causes the parties to inadvertently negotiate criteria that makes the item non-reportable on technical grounds (e.g., adding additional criteria to qualify for the benefit that are not expressly contained in the regulations).  It is not uncommon for these issues to go back years or even decades because the language is rolled over into successor labor agreements.

Under pre-SB 278 law, if CalPERS determined that a disallowed item of compensation was included when calculating a retiree’s retirement benefit allowance, the retiree had to pay CalPERS back the amount of the overpayment, and retirement allowance payments were 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.  Essentially, the individual must pay back and stop receiving that which they were never entitled to in the first place.

SB 278 Transfers Almost All of the Risk of Misreported Compensation to the Employer

SB 278 requires local agencies to pay CalPERS the full cost of any overpayments made to the retiree based on the disallowed compensation and pay a 20-percent penalty of the amount calculated as a lump sum of the actuarial equivalent value of the difference between the retiree’s pension calculated with the disallowed compensation and the pension calculated without the disallowed compensation for the projected duration of the benefit.  In other words, in addition to paying CalPERS directly for any overpayments actually received and retained by the retiree, the employer must also pay a 20-percent penalty of the present value of the projected lifetime and survivor benefit.  Ninety percent of the penalty is paid directly to the retiree and 10 percent is paid as a penalty to CalPERS.  While the remedies are harsh, the version of SB 278 that was originally introduced would have required the employer to pay 100 percent of the value of the lost benefits to the retiree as a lump-sum payment or annuity.

With respect to retired members, the penalty is triggered where the following conditions are met:

  1. The compensation was reported to the system and contributions were made on that compensation while the member was actively employed;
  2. The compensation was agreed to in a memorandum of understanding or collective bargaining agreement between the employer and the recognized employee organization as compensation for pension purposes and the employer and the recognized employee organization did not knowingly agree to compensation that was disallowed;
  3. The determination by the system that compensation was disallowed was made after the date of retirement; and
  4. The determination by the system that compensation was disallowed was made after the date of retirement.

The statutory language raises several questions that will require guidance from CalPERS or may need to be litigated. First, the statute does not explain when compensation was agreed to in a collective bargaining agreement “as compensation for pension purposes.”  For example, if an item of compensation is provided in a collective bargaining agreement and reported to CalPERS, but the collective bargaining agreement is silent on whether the item is reportable to CalPERS, do those two facts in combination trigger the statute?  Prospectively, can employers avoid application of the statute by affirmatively stating in the collective bargaining agreement that no representations are made as to whether an item will be included in pension calculations unless CalPERS affirmatively confirms that the item is reportable?

Second, it is not clear how the retroactive component of the statute will be applied. The statute applies to any prospective determinations and also to determinations made on or after January 1, 2017, if the appeal rights of the retiree have not been exhausted.  A CalPERS’ determination made after the enactment of the statute could potentially apply to decades of previously misreported compensation, and in many cases would impact an entire bargaining group covered by a particular labor agreement.  Employers will likely need to argue that the statute operates only prospectively, except for unresolved ongoing appeals of determinations that were made after January 1, 2017.

Third, and similar to the retroactive issues discussed above, it is uncertain how CalPERS and courts will apply the statute to compensation that was incorrectly reported before January 1, 2022, but where CalPERS’ decision to exclude the compensation is not made until after January 1, 2022.  If the statute is interpreted to have broad retroactive effect, it 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 and compensation carrying unfunded liabilities can be removed from the books.  CalPERS also receives a portion of the prospective reduction of benefits as a penalty against the agency.  The potential combined retroactive liability and penalties 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, the statute does not specify that CalPERS’ approval will be binding and prevent a later negative determination.

Fourth, the statute of limitations applicable to repayment is going to need to be resolved, likely through litigation.  CalPERS has taken the position in the past that the three-year statute of limitations that applies to recovery of overpayments from retirees, does not apply to collections of overpayments from employers.  SB 278 is silent on how far back collections can be pursued for overpayments on determinations that come within the statute’s reach.

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 on the disallowed compensation is returned.  There are no overpayments to address because the employee has not yet retired or started receiving a retirement allowance.

What Can Public Agencies Do Now to Prepare for SB 278

In preparing for SB 278, public agencies should review all their collective bargaining agreements covering CalPERS’ members and scrutinize each item of compensation that is reported to CalPERS to ensure that the item is indeed reportable under applicable statutes, regulations, and administrative guidance.  If not, the agency should take action to correct the language or the practice that makes it non-reportable.  This will not resolve existing liability for overpayments in case of a CalPERS’ audit, but it may reduce the potential liability for future retirees.  These changes would also be subject to meet and confer requirements.  Depending on how aggressively the statutory language is applied, agencies may need to start looking at more drastic measures, such as moving away from special compensation items and to higher base salary, as the majority of these issues involve misreported items of special compensation.