Pension reform will take years

Public pension reform has become a hot-button campaign issue, locally and throughout California, but making significant changes to a pension system cannot be done quickly or easily.

The city of Modesto and Stanislaus County both know that all too well. It took each agency months to negotiate changes that only affect new hires. The county's higher age and lower percentage formula went into effect a year ago; the city's just this month. And this reform, while important long term, is only a baby step, since it didn't affect current employees.

This week, the Modesto City Council decided to look further into what would be a very big step — dropping out of the California Public Employees Retirement System. The council's vote was unanimous and the agenda item drew no public comment because it is something of a no-brainer at this point.

In November, Modesto voters supported Measure Q, one of three advisory pension reform measures promoted by Brad Hawn as part of his mayoral campaign. That measure called for the city to move from the defined benefit plan that it currently has under CalPERS to a defined contribution plan, a 401(k)-type plan that is now in the private sector.

Even before the November election, the city's unions sent a letter asking the council to find out how much it would cost to withdraw from CalPERS.

A figure offered by staff last summer and tossed about in the campaign was $106 million, but that was a very rough estimate.

So this week, the council voted to ask for a firmer number from CalPERS. The calculation will be based on the number of employees the city has; a forecast of when they'll retire and how long they'll live in retirement; and the estimated return on the money that the city and its employees have paid into the retirement system.

On the last point, the city got a bit of bad news. Last summer, CalPERS decided to lower its expected rate of return for cities and other agencies that are terminating from its fund. For active pension plans, CalPERS counts an annual investment return of 7.75 percent. Some years it's higher; some years lower.

For plans in the terminated pool — where Modesto would be if it decides to withdraw — CalPERS invests the money more conservatively, currently figuring a 3.8 percent annual return. A CalPERS spokeswoman explains the reason is to "protect assets, and the pension security of the employees that remain in it because plans in this pool will obviously not be receiving any more employer or employee contributions. What's there will have to last until the last member retires and dies."

If the return rate is lower, it requires a larger investment to make the same amount. So the cost for the city will be higher.

Furthermore, once CalPERS calculates the pension costs for Modesto retirees and existing employees, it will add 7 percent to the total, a cushion to assure that there's enough to pay promised pensions through the life of every retiree.

Once the council has this number, then it also will have to look at the costs of setting up a new retirement system or systems.

And of course that city will have to bargain with its multiple unions on this issue. In bargaining, the council will have to make some critical strategy decisions. Is changing the pension plans more important than, for instance, trying to persuade the employees to take permanent pay cuts or modifying that excessively generous retiree health care arrangement? Which is more important, reducing the employee compensation costs in the next few years or over the next 30 years? It's the kind of deliberation that will require serious financial savvy.

Eventually, if bargaining proves unsuccessful, the council could unilaterally impose a pension plan switch on some of its unions. But disputes with the city's public safety unions go to arbitration, where there is no guarantee that the city's position will prevail.

We don't think it's possible, at this point, to offer a reasonable opinion on whether the city should pursue withdrawing from CalPERS. There are too many unknowns. What seems clear is that withdrawing from CalPERS is a dramatic step that will take years to implement. Pension reform is likely to still be an issue when the next council elections roll around in 2013.