Pension Reform Case Study: SAN JOSE
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Policy Study 429 February 2014 Pension reform case study: san Jose by adam B. summers Reason Foundation Reason Foundation’s mission is to advance a free society by developing, applying and promoting libertarian principles, including individual liberty, free markets and the rule of law. We use journalism and public policy research to influence the frame- works and actions of policymakers, journalists and opinion leaders. Reason Foundation’s nonpartisan public policy research promotes choice, compe- tition and a dynamic market economy as the foundation for human dignity and progress. Reason produces rigorous, peer-reviewed research and directly engages the policy process, seeking strategies that emphasize cooperation, flexibility, local knowl- edge and results. Through practical and innovative approaches to complex problems, Reason seeks to change the way people think about issues, and promote policies that allow and encourage individuals and voluntary institutions to flourish. Reason Foundation is a tax-exempt research and education organization as defined under IRS code 501(c)(3). Reason Foundation is supported by voluntary contribu- tions from individuals, foundations and corporations. The views are those of the author, not necessarily those of Reason Foundation or its trustees. Copyright © 2014, Reason Foundation. All rights reserved. Reason Foundation Pension Reform Case Study: San Jose By Adam B. Summers Executive Summary This study looks at how San Jose, California reduced the burden of its public employee pensions and other post-employment benefits, thereby enabling it to continue to provide a high level of services and avoid bankruptcy. San Jose’s unfunded liability for post-employment benefits grew from $300 million in 2003 to over $4 billion today, of which $2.3 billion is for pensions and $1.8 billion is for retiree health-care. This is in spite of a massive increase in annual pension contributions, which rose from $73 million in 2001 to $245 million in 2012 and now account for 27 percent of its general-fund expenditures. The growth in the city’s unfunded liabilities has many causes, including the financial downturn after 2008. But the primary cause is a massive increase in both salaries and benefits. Between 1991 and 2009, after adjusting for inflation, the average annual benefit for police and fire retirees increased 75 percent, and by 54 percent for other retired city workers. In 2011, average total annual compensation for working police officers was $178,821, for firefighters it was $203,098, and for other city employees $120,092. In the face of these rising costs, San Jose tried to save money by cutting employee salaries and government services. Employees voluntarily accepted wage cuts of 10–18 percent. Other budget cuts were wide ranging, affecting public safety, libraries, sidewalk and park maintenance, and code enforcement. The city even decided not to open four new libraries and a police substation that had been built with bond funds. But these cuts were not enough, so starting in 2010, the city embarked on a series of pension reforms with Measures V and W. These began with changes to the composition of the pension board, removing most insiders and replacing them with independent members with financial and investment expertise. Then, through a pair of ballot measures passed by voters, it limited the amount of compensation increases that could be awarded in arbitration disputes with city workers and gained the ability to shift new city employees to pension plans with lower benefit levels. San Jose’s pension reforms culminated, in June 2012, with the passage of Measure B, under which retirement benefits were reduced for new employees, while current employees had to choose between switching to a plan with reduced benefits or contributing more of their salaries in order to maintain their existing benefits. In addition, the measure: eliminated the “13th checks” that had been issued in the past when the pension investment fund had earned a return higher than a certain threshold, reduced the automatic annual cost-of-living adjustment from 3 percent to 1.5 percent, and required voters to approve any future benefit increases. Measure B passed easily, garnering 69 percent of the vote. However, the measure was not immune from legal challenges and was almost immediately litigated in court by several plaintiff groups made up of current employees and retirees from the City of San Jose. On December 20, 2013, Judge Patricia Lucas of the Santa Clara County Superior Court issued a tentative decision that overturned several key pieces of of Measure B, while simultaneously upholding a majority of the initiative and sustaining substantial savings anticipated in the passage of the measure. With many other cities and states in a similar predicament, San Jose offers one possible model for reform. Among the key lessons from its reforms are the following: • First, prepare the ground by ensuring, if possible, that the pension review board is independent, in order to reduce internal opposition to reform. • Second, recognize the true scope of liabilities from post-employment benefits and communicate these to voters and public employees. • Third, if possible, put proposed reforms to the electorate. • Fourth, use evidence-based arguments backed up by statistics and reports from reputable sources regarding the actual costs of city workers. • Fifth, ensure that voters recognize the alternatives to reform (i.e., in San Jose’s case, fewer services and fewer government jobs). • Sixth, in the proposed reforms, include explicit default alternatives, such as lower pay for government workers, that would be painful to all existing employees. These lessons are of particular use in polities where ballot measures are possible. But even in states that do not allow such measures, it is important to develop a winnable strategy, prepare the ground and stick with a clear message. Though San Jose still faces legal battles with its employee unions over its constitutional authority to deal with pension benefits, the City has nevertheless identified a path toward reform that other financially distressed municipalities around California and across the nation may use to address their mounting pension liabilities before it is too late to avoid fiscal ruin. Reason Foundation Table of Contents The Problem: A Systemically Underfunded Pension ..................................... 1 Background: Rising Costs and Obligations ................................................ 5 A. The History of Pension Benefits in San Jose and in California ............................. 6 B. Service Cuts .................................................................................................. 10 The Retirement Benefit Plans Prior to Reform ............................................ 13 A. SRBR: The “13th Check” .................................................................................. 16 The Reforms ............................................................................................ 18 A. Changing Actuarial Assumptions .................................................................... 18 B. Measures V and W ......................................................................................... 20 C. Measure B ..................................................................................................... 23 The Politics of Reform .............................................................................. 27 A. Challenges Leading up to Reform ................................................................... 27 B. Subsequent Challenges ................................................................................. 30 Lessons Learned ..................................................................................... 32 About the Author .................................................................................... 34 Endnotes ................................................................................................. 35 Pension Reform: San Jose | 1 Part 1 The Problem: A Systemically Underfunded Pension San Jose is the third-largest city in California and the 10th largest in the nation, with a population of just under one million residents.1 It is located in the heart of Silicon Valley, yet despite the region’s massive economic success—or, as we shall see, perhaps partly because of it—San Jose has found itself mired in unfunded pension and retiree health-care liabilities estimated at over $4 billion.2 (See Table 1 for a summary of San Jose’s two pension plans: one for general employees and one for police and fire employees.) The city responded with significant service cuts and employee layoffs, but fears of bankruptcy remained. San Jose is not alone. Local governments throughout California have been struggling with growing, unfunded government-employee pension and health-care liabilities. Some cities—such as Vallejo, Stockton and San Bernardino—have filed for Chapter 9 municipal bankruptcy, largely because their employee-pension contracts became unaffordable. According to a May 2013 USA Today analysis, 10 additional California cities are on the edge of bankruptcy. These jurisdictions, which range from small, rural towns to large cities, include Atwater, Azusa, Compton, Fresno, Hercules, Monrovia, Oakland, San Jose and Vernon. The 10th, Mammoth Lakes, withdrew its petition for bankruptcy after filing last year, but it remains on shaky financial ground. Additionally, late in 2013, there was concern that Desert Hot Springs may also